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V 


51'  J.  LAURENCE  LAUGH  LIS 

BANKING  PROGRESS 
MONBT  AND  PBICIS 
CREDIT  OF  THE  NATIONB 
LATTER-DAT  PROBLFM8 
INDUSTRIAL  AMERICA 
THE  PRINCIPLES  OF  IfONKT 

CHARLES  SCRIBNER'S  SONS 


BANKING  PROGRESS 


i 


BANKING  PROGRESS 


BY 
J.  LAURENCE  LAUGHLIN,  Ph.D. 

BMBBITna   PItOFBSSOH    UP   POUTICAL   ECONOMY    LN    THE    CNIVEBSITT    Of  CHICAGO 


NEW  YORK 

CHARLES  SCRIBNER'S  SONS 

1920 


08857 


COPTBIGHT,   1920,   BT 

CHARLES  SCRIBNER'S  SONS 


Published  May,  1920 


tK 


PREFACE 

The  story  of  growth,  a  progress  from  a  lower  to  a 
higher  plane,  is  always  of  absorbing  interest  in  any  field. 
In  the  evolution  of  our  thinking  on  banking  we  have  the 

r^    complement  to  the  history  of  our  monetary  development 

^  out  of  the  greenback  and  silver  stages.  Although  the 
two  phases,  of  progress  are  more  or  less  related,  the  main 
'^N'^  significance  of  our  banking  progress  is  to  be  found  in  the 
gradual  understanding  of  the  workings  of  credit,  and  the 
emphasis  which  has  inevitably  been  placed  on  the  organi- 
zation and  flexibility  of  credit  as  a  part  of  our  industrial 
:^1  ,  growth.    Even  though  the  meaning  of  separate  events 

fQ    was  not  clear  at  the  time  of  their  occurrence,  a  glance 
backward   from  our  present  position   shows   very   dis- 
tinctly the  country  through  which  the  road  has  been 
winding. 
1       Having  been  myself  in  close  touch   with  the  move- 
j  ments  which  from  time  to  time  marched  with  our  mon- 

5.  etary  and  banking  progress,  it  has  been  inevitable  that 
my  presentation  should  have  the  marks  of  the  period  in 
which  the  questions  at  issue  were  fought  out.  Indeed 
much  of  the  material  in  this  volume  came  forth  as  a  part 
of  the  effort  to  aid  in  directing  public  opinion  to  an  in- 
telligent solution  of  diflScult  questions.  Perhaps,  for  this 
reason,  if  for  no  other,  they  should  have  some  historical 
value.  But,  in  college  courses  on  banking  it  may  be 
worth  while  to  have  in  compact  form  the  sequence  of 


vi  PREFACE 

events  which  led  finally  to  the  possibility  of  the  Federal 
Reserve  Act. 

Inasmuch  as  active  charge  of  the  educative  campaign 
leading  up  to  the  enactment  of  the  Federal  Reserve  sys- 
tem was  laid  upon  me,  I  have  been  repeatedly  urged  to 
set  down  the  inside  history  of  the  movement.  It  is  too 
soon,  however,  to  publish  any  such  account.  But  it  has 
seemed  justifiable  to  give  to  the  public  the  exact  bill  with 
its  commentary  (Chapter  IX)  which  was  in  1912-1913 
offered  by  me  to  the  framers  of  the  bill.  That  it  was  mis- 
represented at  the  time  goes  without  saying.  Its  perusal 
will  show  that  its  recommendations  regarding  the  note- 
issues  were  not  followed.  One  reason,  to  my  mind,  why 
its  appearance  now  may  be  timely  is  the  acute  condition 
to-day  of  the  note-issues  and  reserves,  resulting  from  our 
war  financing,  which  suggests  that  important  changes 
may  be  ahead  of  us  in  order  better  to  protect  our  note- 
issues  from  undue  expansion,  and  better  to  separate  our 
issue  from  our  discount  and  deposit  functions  of  bank- 
ing. It  seems  strange  that  in  the  most  important  bank- 
ing enactment  of  our  history  we  should  have  gone  back 
in  effect  to  the  practice  of  the  old  United  States  Bank 
wherein  one  cash  reserv^e  was  kept  for  both  demand- 
liabilities,  notes  and  deposits.  The  account  of  the  work- 
ing of  the  Federal  Reserve  Act  for  the  five  years  since 
its  enactment  (Chapter  XI)  shows  some  shortcomings 
both  in  poHcy  and  structure  which  demand  attention, 
especially  in  view  of  the  responsible  position  that  we 
have  assumed  in  the  world  of  credit. 

J.  Laurence  Laughun. 

Boston,  March,  19i20. 


CONTENTS 

CHAPTER  I.    THE  STANDARD  QUESTION 

PAOB 

§  1.     Evolution  from  Money  to  Credit 1 

§  2.     Gold  Standard  Not  Firmly  Established  in  1900     ...  2 

§  3.     Bonds  Still  Payable  in  Silver 4 

§  4.     Gold  Must  Still  Be  Stipulated  in  Private  Contracts     .      .  8 

§  5.    No  Means  for  Keeping  Silver  at  Par  with  Gold      ...  8 

§  6.     Separation  of  Gold  Reserves  from  General  Funds  ...  14 

§  7.     Politics  Affected  the  Term  of  Bonds  Refunded  ....  16 

CHAPTER  n.    ELASTICITY  OF  BANK-ISSUES 

§  1.     Attention  Directed  to  Elasticity 19 

§  2.     Inelasticity  of  National  Bank-Notes 20 

§  3,     "Asset-Currency"  Proposed  in  Baltimore  Plan       ...  26 

§  4.     How  Received 28 

§  5.     Limited  Only  to  Note-Issues 30 

§  6.     Errors  Regarding  Banks  and  Money 32 

§  7.     Elasticity  Furthered  by  Monetary  Commission  of  1898    .  36 

CHAPTER  m.    INFLUENCE  OF  THE  PANIC  OF  1907 

§  1.    The  Function  of  an  Elastic  Currency 38 

§  2.    Real  Need  for  Elasticity  in  Lending  Power 41 

§  3.     The  Bankers'  Plan  of  1908 45 

§  4.    How  to  Meet  a  Crisis 47 


viii  CONTENTS 

CHAPTER  IV.    THE  ALDRICH-VREELAND  ACT 

PAGE 

§  1.  Political  Reasons  for  the  Act 50 

§  2.  Legislative  History  of  the  Bill 54 

§  3.  Effect  of  the  Bond  Requirement 62 

§  4.  Both  Bonds  and  Commercial  Paper  Accepted  ....  64 

§  5.  Securities  of  Any  Kind  Admitted 66 

§  6.  Misconception  as  to  Commercial  Paper 75 

CHAPTER  V.    GUARANTY  OF  BANK-DEPOSITS 

§  1.  Origin  of  the  Scheme 81 

§  2.  The  Plan  Stated 82 

§  3.  Different  Positions  of  Noteholder  and  Depositor     ...  85 

§  4.  The  Depositor  Acts  Voluntarily 87 

§  5.  The  Plan  Socialistic 89 

§  6.  Safety  of  Deposits  Depends  on  the  Quality  of  Bank  Assets  91 

§  7.  Guaranty  Not  a  Cure  for  Panics 92 

§  8.  Power  to  Change  Deposits  into  Notes 97 

§  9.  Relation  of  Guaranty  to  Bad  Banking 100 

§10.  The  Question  of  Technical  Insurance 103 

§11.  The  Appeal  to  History 105 

CHAPTER  \I.    THE  DEPOSITOR  AND  THE  BANK 

§  1.  Relations  of  Depositors  to  the  Bank 107 

§  2,  The  Guaranty  as  a  Matter  of  Justice 108 

§  3.  Already  Have  Ultimate  Redemption 110 

§  4.  Immediate  Redemption  Impossible 112 

§  5.  Absolute  Security  Asked 113 

§  6.  Guaranty  Attempts  to  Equalize  All  Banks 114 

§  7.  Experience  of  Oklahoma 118 

§  8.  State  vs.  National  Banks 120 

§  9.  Appeal  for  "More  Money" 122 


CONTENTS  ix 
CHAPTER  Vn.    BANK-NOTES  AND  LENDING  POWER 

PAQB 

§  1.    The  National  Monetary  Commission 124 

§  2.    Function  of  Notes  in  a  Crisis 125 

§  3.    In  a  Panic  the  Real  Need  Is  a  Loan 131 

§  4.    Lending  Power  in  France  and  England 134 

§  5.    Essential  Remedies  for  Crises 137 

CHAPTER  Vin.    POLITICAL  HISTORY  OF  THE 
FEDERAL  RESERVE  ACT 

§  1.    Influence  of  the  Act  of  1908 143 

§  2.    The  Aldrich  Plan  and  Democratic  Policy 145 

§  3.    Origin  of  the  Bill 150 

§  4.    A  Memorandum  on  the  Political  Situation 153 

§  5.     Methods  of  Congressional  Legislation 155 

§  6.     Confusion  as  to  Banking  Functions 157 

CHAPTER  IX.    A  PROPOSED  BILL 

§  1.    Authorship  of  This  Proposed  Bill 160 

§  2.     Introduction 161 

§  3.     Centralization 163 

§  4.     Provisions  on  Organization 166 

§  5.     Discounts 171 

§  6.    The  Treasury  Board  and  Advisory  Board 176 

§  7.    District  or  Reserve  Associations 180 

§  8.     Note-Issues 184 

§  9.    Disposal  of  Bonds 198 

§10.     Reserves 200 

§11.     Disposal  of  Earnings 205 

§12.    The  Independent  Treasury 208 

§13.     Foreign  Banking 209 

§14.    Reports  and  Examinations 210 

§15.    Clearings  and  Collections  ... 212 


X  CONTENTS 

CHAPTER  X.    THE  FEDERAL  RESERVE  ACT 

PAOB 

§  1.     Defects  To  Be  Remedied 216 

§  2.     Control  and  Organization 217 

§  3.     Federal  Reserve  Banks 227 

§  4.    Note-Issues 237 

§  5.    Disposal  of  Bonds 245 

§  6.     Reserves 249 

§  7.    The  Organization  of  Credit 257 

§  8.     Clearings 268 

§  9.    A  Discount  Market 272 

§10.     Foreign  Banking 274 

§11.     The  Independent  Treasury 275 

§12.    The  Entry  of  State  Banks 276 

CHAPTER  XI.    WORKING  OF  THE  FEDERAL 
RESERVE  ACT 

§  1.     Establishment  of  a  Discount  Policy 278 

§  2.     Reserves 285 

§  3.    Admission  of  State  Banks 288 

§  4.     Clearings 291 

§  5.     The  Gold  Basis 294 

§  6,     Foreign  Relations 296 

§  7.     Effects  of  the  War 297 

§  8.     Notes 301 

§  9.     Expansion  of  Credit 308 

§10.     Lessons  from  Experience 312 

APPENDIX  I 

Plan  of  the  American  Bankers'  Association 319 

APPENDIX  n 

Plan  of  the  National  Monetary  Commission 826 

Index 347 


BANKING  PROGRESS 


CHAPTER  I 
THE  STANDARD  QUESTION 

§  1.  The  concentration  of  public  attention  on  burning 
monetary  and  banking  questions  of  the  day  as  they 
arose,  as  they  were  fought  over  and  met  more  or  less  by 
legislation,  may  have  prevented  the  most  of  us  from  seeing 
what  has  been  the  actual  drift  of  monetary  and  banking 
thinking  over  the  important  period  of  the  last  twenty- 
five  years.  We  may  not  have  been  able  to  see  the  forest 
for  the  trees.  Yet  these  years  have  witnessed  the  most 
far-reaching  changes  in  our  understanding,  as  a  country, 
of  money  and  credit.  The  progressive  steps  in  our  de- 
velopment from  questions  of  the  standard  to  those  of 
the  elasticity  of  the  currency  and  finally  to  those  of  the 
elasticity  of  credit  are  full  of  instruction.  They  record 
the  evolution  of  our  monetary  and  banking  thinking. 
This  evolutionary  study,  moreover,  brings  out  the  inter- 
relation of  money  with  banking  and  of  banking  with 
money  both  in  theory  and  in  practice.  As  we  look  back 
upon  them  these  events  drop  into  a  logical  sequence; 
but  at  the  time  each  step  was  taken  we  were  then  very 
much  in  the  dark.  In  fact,  we  were  forced  into  progress 
not  so  much  by  conscious  wisdom  as  by  the  stern  lessons 
of  hard  experience  in  two  panics. 

The  panic  of  1893,  due  to  a  fear  of  falling  to  a  silver 
standard,  caused  an  upheaval  of  all  our  credit  and  bank- 
ing operations.  In  that  year  we  broke  with  our  silver 
folly  and  ceased  further  purchases  of  silver  by  law. 
Then  succeeded  such  a  stirring  of  public  interest  in  money 
and  banking  that  we  may  well  date  our  present  fortunate 

1 


2  BANKING  PROGRESS 

situation  to  the  progress  then  set  in  motion.  It  came  to 
be  understood  that  a  bad  currency  and  banking  system 
in  itself  could  produce  a  ruinous  upheaval  of  business. 
The  business  interests  of  the  country,  realizing  that  in 
the  past  monetary  matters — as  with  the  greenback  and 
silver  manias — had  been  neglectfully  relegated  to  our 
politicians,  at  last  became  aroused  and  set  to  work  to 
effect  some  essential  reforms.  To  lay  a  foundation  for 
succeeding  changes  the  standard  question  was  vigorously 
discussed.  That  was  elemental  for  a  further  treatment  of 
currency  and  credit.  The  cessation  of  silver  purchases 
in  1893  had  to  be  followed  up  by  positive  action  to  fix 
the  standard.  Then  came  the  so-called  Gold  Standard 
Act  of  1900.  How  far  it  has  safely  secured  to  us  the 
gold  standard  is  of  first  importance. 

§  2.  At  the  time  of  the  passage  of  this  legislation  it 
was  repeated  by  the  public  press,  and  assumed  by  the 
country,  chiefly  on  the  basis  of  reports  emanating  from 
Washington,  that  the  act  of  March  14,  1900,  whatever 
may  have  been  its  shortcomings  in  other  directions,  had 
at  least  firmly  established  the  gold  standard  in  the  United 
States.  The  belief  was  generally  prevalent  that  the 
election  of  a  President  pledged  to  the  cause  of  free  silver 
could  no  longer  be  a  source  of  danger  to  our  monetary 
system,  because  the  gold  standard  had  been  placed  by 
the  new  legislation  beyond  the  reach  of  executive  control ; 
that  the  mere  action  of  a  future  secretary  of  the  treasury 
hostile  to  gold  could  not  cause  public  or  private  obliga- 
tions to  be  paid  in  silver;  and  that  nothing  could  now  be 
done  for  silver  except  by  new  and  positive  legislation,  a 
contingency  which  would  be  impossible  so  long  as  the 
Senate  and  the  Executive  favored  gold.  Hence  we  were 
assured  that  we  could  rest  free  from  all  danger  of  the 


THE  STANDARD  QUESTION  3 

"silver  issue,"  which  we  heard  on  all  sides  was  "dead." 
On  the  strength  of  this  belief,  political  lines  were  drawn, 
and  a  plan  of  campaign  was  formed.  That  there  had  been 
a  subtle  game  of  politics  played  with  our  monetary  legisla- 
tion through  the  influence  of  the  Senate  was  unmistakably 
clear  but  was  nothing  unusual  or  surprising.  It  is  not 
certain,  however,  that  the  general  public  was  aware  of 
the  exact  effect  of  the  provisions  of  the  new  \aw,  or  in- 
formed how  little  had  been  done.  Indeed,  it  may  be 
a  surprise  to  many  to  be  told  that,  as  regards  the  estab- 
lishment of  the  gold  standard,  not  only  had  practically 
nothing  new  been  introduced  into  the  situation  by  this 
•law,  but  that  we  have  in  general  no  new  means  of  main- 
taining the  standard  which  we  did  not  have  before  the 
act  was  passed.  If  there  had  been  possible  danger  from 
silver  before  March  14,  1900,  the  same  danger  still  exists, 
except  so  far  as  we  have  been  protected  by  the  act  of 
December  23,  1913.i 

In  speaking  of  the  gold  standard  as  firmly  established, 
one  means  the  obhgation  to  pay  gold  whenever  the  word 
"dollars"  is  used.  As  every  one  knows,  the  word  "coin" 
allowed  an  uncertainty  as  to  whether  a  contract  gener- 
ally payable  in  "dollars"  could  be  paid  in  silver  dollars 
(of  3713^  grains  pure  silver)  or  in  gold  dollars  (of  23.22 
grains  pure  gold).  This  imcertainty  in  regard  to  United 
States  bonds  in  previous  years  seriously  affected  their 
value,  and  was  one  strong  reason  why  new  legislation 
was  thought  to  be  necessary  to  remove  all  doubt.  It 
may,  therefore,  be  a  shock  to  some  trusting  people  to  be 
told  that,  in  spite  of  the  new  law,  a  silver-loving  secre- 
tary of  the  treasury  could  yet  pay  off  large  amounts 
of  government  obligations  with  silver  dollars.  If  a  free- 
silver  President  had  entered  the  White  HoXise  in  1901, 

»e/.  Chapter  X,§  4. 


4  BANKING  PROGRESS 

there  would  have  been  a  large  amount  of  obligations 
which  could  then  have  been  paid  in  silver. 

§  3.  Even  if  the  standard  of  payments  and  prices 
may  now  in  practice  be  gold,  as  regards  both  government 
and  private  debts,  it  is  important  to  know  how  perma- 
nent this  situation  is.  For  simphcity,  the  matter  of 
government  bonds  will  be  discussed  first.  How  did  the 
act  of  March  14,  1900,  affect  the  "coin"  provision  in 
which  national  obligations  are  payable.'' 

The  contention  which  arose  soon  after  the  Civil  War, 
that  the  debt  of  the  United  States  wac  payable  in  paper, 
was  settled  in  fact  by  the  actual  refunding  of  the  whole 
debt  under  the  act  of  July  14,  1870,  which  provided  that 
the  bonds  issued  under  this  law  should  be  "redeemable 
in  coin  of  the  present  standard  value."  Obviously  this 
phrase  referred  to  the  standard  coin  existing  before  the 
act  of  1873,  and  which  then  included  silver  dollars  (of 
371]^  grains  pure  silver)  as  well  as  gold  dollars.  Of 
course,  silver  dollars  were  worth  more  than  gold  dollars 
in  1870;  and,  as  we  all  know,  both  gold  and  silver  coins 
had  been  driven  from  circulation  by  the  depreciated 
United  States  notes;  but  such  facts  are  not  to  the  point. 
Coin,  in  our  law  in  1870,  included  the  silver  dollar,  whether 
it  was  in  circulation  or  not.  Hence  all  the  bonds  re- 
funded under  the  act  of  1870  were  payable  at  the  dis- 
cretion of  the  Treasury  either  in  silver  or  gold  dollars. 

The  act  of  February  12,  1873  ("the  crime  of  1873"), 
did  not  abolish  the  legal  tender  value  of  any  of  the  few 
silver  dollars  which  might  then  have  been  in  existence. 
It  simply  omitted  to  provide  for  the  future  coinage  of 
silver  dollars  (sec.  15  and  17);   and  added  (sec.  14): 

That  the  gold  coins  of  the  United  States  shall  be  a  one- 
dollar  piece,  which  at  the  standard  weight  of  twenty-five  and 
eight-tenths  grains,  shall  be  the  unit  of  value,  etc. 


THE  STANDARD  QUESTION  5 

It  will  be  seen,  then,  no  matter  what  other  considera- 
tions may  be  adduced,  that  under  the  law  in  1870 
"coin"  certainly  included  silver  dollars;  and  that  the 
act  of  1873  did  not  change  this  situation.  And  in  de- 
claring the  gold  dollar  to  be  "the  unit  of  value"  it  did 
not  forbid  the  use  of  silver  dollars  in  any  payments 
public  or  private.  The  limitation  on  the  legal  tender 
power  of  silver  coins  in  1874  was  the  only  change  intro- 
duced at  that  time.^ 

The  subsequent  fact  of  importance  was  that  all  bonds 
of  later  issue  (until  the  Spanish  War  Loan  of  1898)  had 
been  based  upon  the  provisions  of  the  act  of  July  14, 
1870.  That  is,  the  4  per  cents  of  1907  were  issued  un- 
der that  act.  Also,  any  bonds  put  out  under  the  terms 
of  the  Resumption  Act  of  January  14,  1875,  in  order  to 
obtain  gold,  were  "of  the  same  description  as  those  issued 
by  the  act  of  July  14,  1870."  Thus  the  extended  2s 
(of  the  loan  of  1891),  5  per  cents  of  1904,  and  the  4  per 
cents  of  1925,  are  covered  by  this  latter  statement. 
The  United  States  bonds  thus  stood  at  the  time  of  the 
passage  of  the  act  of  March  14,  1900,  all  payable  in 
"coin": 


4  per  cent  bonds,  1907 $559,652,300 

6  "   "    "   1904 100,000,000 

2  "   "    "   1891  (extended) 26.364,600 

4  "   "    "   1925 162,315,400 

3  "   "    "   1898 198,678,720 


$1,046,010,920 


The  act  of  March  14,  1900,  authorized  a  partial  re- 
funding of  the  old  debt  into  2  per  cent  bonds,  whose 
principal  and  interest  was  made  specifically  payable  in 

^  The  revised  statutes  of  June  22, 1874,  inserted  a  pro^nsion  (sec.  3586)  which 
limited  the  legal  tender  power  of  all  our  silver  coins  to  sums  not  exceed- 
ing $5. 


6  BANKING  PROGRESS 

"gold  coin  of  the  present  standard  value."  It  did  not 
allow  the  refunding  into  the  new  2s  of  the  extended  2s 
of  1891,  nor  the  4  per  cents  of  1925 — in  all  a  sum  of 
$187,679,900.  In  May,  1900,  however,  the  extended 
2s  were  called  in  for  redemption,  so  that  the  bonds  of 
1925  were  the  only  ones  in  fact  excluded.  About  the 
close  of  the  European  War  (June  30,  1918)  there  still  re- 
mained outstanding  $118,489,900  of  these  4  per  cents  of 
1925.  Therefore,  prevented  only  by  the  fact  that  they 
did  not  mature  until  1925,  a  secretary,  opposed  to  the 
gold  standard,  might,  on  a  change  of  parties,  have  paid 
off  on  their  maturity,  in  silver,  since  1900,  an  amount 
of  these  4  per  cents  varj-mg  from  $118,489,900  to  $162,- 
315,400. 

The  possible  dangers  in  the  act,  so  far  as  our  national 
bonds  are  concerned,  have  been  practically  removed  by 
the  subsequent  working  of  refunding  measures.  But  no 
thanks  are  due  to  the  framers  of  this  law.  In  effect, 
the  mi  certainty  of  the  few  years  after  1900  has  disappeared 
because  practically  all  of  the  old  debt  has  been  refunded 
in  later  years  into  the  2  per  cent  consols  of  1930  which 
are  specifically  payable  in  gold. 

With  the  above  situation  it  must  be  kept  in  mind  that 
the  act  of  March  14,  1900,  specifically  enacted  (sec.  3): 

That  nothing  contained  in  this  act  shall  be  construed  to  affect 
the  legal  tender  quality,  as  now  provided  by  law,  of  the  silver 
dollar,  or  of  any  other  money  coined  or  issued  by  the  United 
States. 

That  is,  the  act  of  February  28,  1878,  which  made  the 
silver  dollars  "a  legal  tender,  at  their  nominal  value,  for 
all  debts,  public  and  private,  except  where  otherwise 
expressly  stipulated  in  the  contract,"  is  still  in  operation. 
The  outcome  is  a  visible  attempt  to  sit  on  two  stools: 


THE  STANDARD  QUESTION  7 

in  one  word  to  declare  that  the  gold  dollar  shall  be  the 
standard  unit  of  value,  and  in  another  to  declare  that 
the  silver  dollar  shall  remain  an  unhmited  legal  tender. 
The  political  legerdemain  in  this  action  depends  upon  the 
inabihty  of  the  pubHc  to  separate  the  assignment  of  legal 
tender  quahty'to  the  standard  (in  which  prices  and  con- 
tracts are  expressed)  from  the  assignment  of  it  to  a  token 
money  (which  should  be  redeemable  in  the  standard 
money).  Because  the  standard  money  is  made  legal 
tender,  it  does  not  follow  that  a  medium  of  exchange 
(such,  for  example,  as  national  bank  notes,  or  checks  and 
drafts)  should  have  that  quality. 

The  dodging  of  the  standard  issue  in  regard  to  govern- 
ment obligations  cannot  be  excused  on  the  ground  of 
inadvertence.    The  House  bill  (sec.  2)  read: 

That  all  interest-bearing  obligations  of  the  United  States 
for  the  payment  of  money,  now  existing  or  hereafter  to  be 
entered  into,  .  .  .  shall  be  deemed  and  held  to  be  payable 
in  the  gold  coin  of  the  United  States  as  defined  in?  section  1 
of  this  act. 

These  words  did  not  appear  in  the  Senate  bill,  and  were 
excluded  from  the  conference  bill.  In  short,  for  political 
reasons,  the  Senate  leaders  advisedly  chose  to  modify 
the  currency  measure  in  such  a  way  that  it  could  still 
be  said  that  a  large  part  of  our  national  obligations  were 
payable  in  silver;  while  scheming  for  votes  in  the  East 
on  the  ground  of  having  established  the  gold  standard, 
it  would  be  possible  to  ask  for  votes  in  the  Rocky  Moun- 
tain States  on  the  ground  of  having  preserved  the  right 
to  pay  a  large  part  of  the  bonds  in  silver.  It  must  be 
said,  therefore,  that  the  new  act  established  the  pay- 
ment in  gold  of  only  a  part  of  our  government  obliga- 
tions in  existence  at  that  time  (and  also  that  this  amount 


8  BANKING  PROGRESS 

depended  upon  how  far  they  were  later  refunded  into  the 
new  2s). 

§  4.  The  consideration,  however,  of  most  importance 
to  the  business  public  is  the  certainty  of  the  standard 
in  ordinary  private  contracts  drawn  in  "dollars,"  with- 
out a  specific  agreement  to  pay  gold.  Obviously,  it 
may  be  said  that  the  national  bonds  could  not  be  paid 
in  silver  in  any  event  until  the  time  of  maturity,  and 
that  such  a  fear  need  not  give  much  cause  for  distrust. 
But  as  to  private  debts,  falling  due  from  day  to  day, 
every  one  realizes  it  to  be  a  matter  of  present  concern. 
Since  the  unUmited  legal  tender  power  of  the  silver  dol- 
lar is  retained  for  all  obligations  in  which  gold  is  not 
expressly  stipulated,  it  is  clear  that  all  private  contracts 
thus  generally  drawn  could  be  liquidated  in  silver.  The 
gold  standard  of  payments,  therefore,  is  not  made  obliga- 
tory for  private  debts.  The  new  law  manifestly  did  not 
establish  the  gold  standard  for  the  ordinary  transac- 
tions of  daily  business  life.  If  a  lender  of  money  wishes 
to  secure  repayment  in  gold,  he  must,  to-day,  as  well 
as  before  this  act  was  passed,  expressly  stipulate  for 
gold  in  the  contract.  The  act  of  March  14,  1900,  did 
not  give  us  any  new  protection  in  this  regard.  Hence 
we  ought  to  give  up  the  fiction  that  the  new  law  "es- 
tablished the  gold  standard." 

§  5.  Since  silver  dollars  can  be  paid  for  public  and 
private  debts  in  nearly  as  many  cases  now  as  before  the 
act  of  1900,  the  question  then  arises  as  to  whether  the 
permanence  of  the  gold  standard  had  been  assured  by 
any  provisions  for  maintaining  silver  at  par  with  gold. 
Certainly,  a  reader  might  say,  so  long  as  silver  is  kept 
in  value  equal  to  gold,  no  one  would  object  to  being  paid 


THE  STANDARD  QUESTION  9 

in  silver;  and  reference  might  be  made  to  the  fact  that 
the  act  (sec.  1)  not  only  declared  the  gold  dollar  to  be 
"the  standard  unit  of  value,"  but  also  that  "all  forms  of 
money  issued  or  coined  by  the  United  States  shall  be 
maintained  at  a  parity  of  value  with  this  standard,  and 
it  shall  be  the  duty  of  the  Secretary  of  the  Treasury  to 
maintain  such  parity."  To  the  innocent  reader  this 
may  look  like  a  veritable  establishment  of  the  parity  of 
silver  with  gold.  But  it  adds  nothing  that  did  not 
exist  in  the  law  before  (in  the  acts  of  July  14,  1890,  and 
November  1,  1893).^  It  pretends  to  estabhsh  parity  by 
command,  but  it  gives  absolutely  nothing  with  which 
to  maintain  parity.  Suppose  that  Congress  had  ordained 
that  the  navy  should  have  had  all  the  old  powder  ex- 
changed for  smokeless  powder,  and  that  it  should  have 
made  it  the  duty  of  the  secretary  of  the  navy  to  make 
such  exchange,  and  had  provided  no  appropriation  for 
this  purpose,  nor  allowed  any  new  machinery  for  carry- 
ing out  the  plan  beyond  what  existed  before.  Should  we 
not  regard  this  as  something  more  than  trickery?  Cer- 
tainly: it  would  be  an  insult  to  the  intelligence  of  the 
public.     In  that  monetary  law,  we  had  actually  no  means 

'  Act  of  July  14,  1890  (sec.  2):  "That  upon  demand  of  the  holder  of  any  of 
the  Treasury  notes  herein  provided  for  the  Secretary  of  the  Treasury  shall, 
under  such  regulations  as  he  may  prescribe,  redeem  such  notes  in  gold  or  silver 
coin,  at  his  discretion,  it  being  the  established  policy  of  the  United  States  to 
maintain  the  two  metals  on  a  parity  with  each  other  upon  the  present  ratio, 
or  such  ratio  as  may  be  provnded  by  law." 

Act  of  November  1,  1893:  "And  it  is  hereby  declared  to  be  the  policy  of 
the  United  States  to  continue  the  use  of  both  gold  and  silver  as  standard  money, 
and  to  coin  both  gold  and  silver  into  money  of  equal  intrinsic  and  exchange- 
able value,  such  equality  to  be  secured  through  international  agreement,  or  by 
such  safeguards  of  legislation  as  wiU  insure  the  maintenance  of  the  parity  in 
value  of  the  coins  of  the  two  metals,  and  the  equal  power  of  every  dollar  at  all 
times  in  the  markets  and  in  the  payment  of  debts.  And  it  is  hereby  further 
declared  that  the  efforts  of  the  Government  should  be  steadily  directed  to  the 
establishment  of  such  a  safe  system  of  bimetallism  as  will  maintain  at  all  times 
the  equal  power  of  every  dollar  coined  or  issued  by  the  United  States,  in  the 
markets  and  in  the  payment  of  debts." 


10  BANKING  PROGRESS 

of  maintaining  silver  dollars  at  par  with  gold  which  did 
not  exist  before  the  act  was  passed.  Here  again,  the 
jugglery  of  the  Senate  leaders  showed  itself.  The  House 
bill  ran  (sec.  4): 

The  Secretary  of  the  Treasury  is  authorized  and  required 
to  use  said  [gold]  reserve  in  maintaining  at  all  times  the  parity 
and  equal  value  of  every  dollar  iss^ied  or  coined  by  the  govern- 
ment; and  if  at  any  time  the  Secretary  of  the  Treasury  deems 
it  necessary  in  order  to  maintain  the  parity  and  equal  value 
of  all  the  money  of  the  United  States,  he  may  at  his  discretion 
exchange  gold  coin  for  any  other  money  issued  or  coined  by 
the  United  States. 

In  short,  the  House  bill  set  out  to  provide  a  gold  re- 
serve to  be  used  for  the  maintenance  of  the  parity  of 
all  kinds  of  our  money;  but  the  Senate  overruled  this 
plan,  and  limited  the  use  of  the  gold  reserve  solely  to 
United  States  notes  and  treasur}^  notes  of  1890.  That 
is,  if  the  Treasury  should  find  difficulty  in  keeping  about 
579,000,000  of  silver  dollars  at  par  with  gold,  he  could 
not  use  the  new  gold  reserve  (for  the  replenishment  of 
which  provision  was  made  by  selling  bonds).  All  the 
regulations  of  the  reserve  applied  to  the  two  forms  of 
paper  (amounting  to  about  $426,000,000),  while  about 
575,000,000  dollars  of  silver,  which  carried  a  seignorage 
of  over  50  per  cent,  were  left  without  any  direct  means  of 
redemption  into  gold,  as  a  means  of  keeping  the  parity. 
I  have  said  that  the  permanence  of  the  gold  standard 
depends  upon  the  provisions  of  that  law  as  to  maintain- 
ing the  parity  between  gold  and  silver;  but  we  now  see 
that  no  new  means  whatever  had  been  given  to  ac- 
complish this  end.  Such  methods  of  keeping  silver  at  a 
parity  with  gold  which  existed  before  the  act  of  March 
14,  1900,  are  still  the  only  means  we  now  have  of  assuring 
the  continuance  of  the  gold  standard.     That  law  had  not 


THE  STANDARD  QUESTION  11 

given  us  any  new  methods  of  redemption.^  Here  we 
had  an  exliibition  of  gross  cowardice  on  the  part  of  Con- 
gress. Although  no  other  enactments  have  been  later 
made  for  gold  reserves  against  United  States  notes  or 
silver  currency,  yet  so  long  as  Federal  Reserve  notes 
remain  redeemable  in  gold  as  required  by  the  act  of 
December  23,  1913,  all  other  forms  of  money  which  are 
in  practice  used  mterchangeably  with  Reserve  notes  will 
have  the  same  value. 

In  one  respect,  however,  that  legislation  bettered  the 
chances  of  keeping  our  silver  at  par  with  gold.  By  the 
withdrawal  of  United  States  notes  and  national  bank 
notes  (except  one-third  of  the  new  circulation)  in  de- 
nominations below  $10,  and  by  reducing  the  large  silver 
certificates  to  small  denominations  to  take  their  place, 
an  additional  use  was  created  for  the  silver  money,  and 
therefore  there  will  be  less  reason  for  its  redundancy 
and  consequently  for  its  presentation  at  the  Treasury 
in  payment  of  customs  in  a  process  of  indirect  redemp- 
tion. By  increasing  the  probability  of  keeping  silver 
permanently  in  circulation  for  purposes  of  change  it  be- 
came less  dangerous. 

But  this  gain  was  fully  offset  by  the  provisions  of  the 
act  which  affected  the  silver  bullion  behind  the  treasuiy 
notes  of  1890,  and  which  increased  the  quantity  of 
silver  dollars  to  be  kept  at  a  parity.  Here  we  have 
another  sop  to  Cerberus.  From  a  sane  point  of  view  it 
is  not  much  more  creditable  than  the  measure  to  coin 
the  seignorage  which  was  defeated  some  years  before. 
Under  the  act  of  July  14,  1890,  168,674,682.53  ounces  of 

'  How  silver  has  been,  in  fact,  kept  at  par  with  gold  in  the  past  by  an  in- 
direct system  of  redemption  through  the  payment  of  customs,  and  by  the 
complementary  offer  of  gold  to  all  creditors  of  the  Treasury,  I  need  not  go 
into  here.  Cf.  my  History  of  Bimetallism  in  the  United  States,  4th  ed.,  pp. 
253-255.     Cf.  Chapter  X,  §  4,  for  effect  of  the  Federal  Reserve  Act. 


n  BANKING  PROGRESS 

fine  silver  were  bought  by  the  issue  of  $155,931,002.25 
of  treasury  notes.  The  average  price  paid  per  ounce 
for  this  bullion  was  $0.9244;^  and  as  the  price  soon  fell 
about  one-third,  the  value  behind  the  notes  became 
one-third  less.  But  if  this  bullion  were  coined  into  silver 
dollars  (at  the  rate  of  371 M  grains  each),  the  168,674,- 
682.53  fine  ounces  would  yield  about  218,000,000  silver 
dollars.  Then,  instead  of  $155,931,002.25  treasury  notes 
to  look  after,  there  would  have  been  a  vastly  larger  bulk 
of  silver  dollars  to  be  added  to  those  previously  coined 
under  the  act  of  1878.  The  disposition  of  this  bullion 
is  a  fair  test  of  the  animus  of  the  new  legislation.  One 
bit  of  help  existed  in  the  permission  to  use  enough  of  the 
bullion  to  increase  the  subsidiary  coinage  to  100,000,000 
dollars;  and  since  the  amount  outstanding  March  1, 
1900,  was  $80,101,151,  it  appears  that  an  increase  of 
nominal  face  value  to  the  sum  of  about  20,000,000  dol- 
lars (or  about  14,000,000  fine  ounces)  was  possible. 
With  this  exception  the  act  emphasized  the  pohcy  of 
coining  the  rest  of  the  bullion  into  dollar  pieces  and  re- 
tiring the  treasury  notes.  It  is  doubtless  generally  un- 
derstood how  the  terms  of  the  act  of  July  14,  1890,  has 
in  fact  brought  about  a  gradual  extinction  of  treasury 
notes  of  1890.  This  process  was  estabUshed  in  the  words 
(sec.  2): 

No  greater  or  less  amount  of  such  notes  shall  be  outstanding 
at  any  time  than  the  cost  of  the  silver  bullion  and  the  standard 
silver  dollars  coined  therefrom,  then  held  in  the  treasury 
purchased  by  such  notes. 

Hence  treasury  notes,  when  redeemed  by  gold,  would 
be  reissued  in  order  to  keep  the  amount  equal  to  the 

^The  rise  in  the  price  of  silver  bullion  to  over  $1.30  in  1919  would  make  it 
possible  for  the  Treasury  to  reduce  its  holdings  at  a  profit.  But  this  rise 
could  not  possibly  have  been  foreseen. 


THE  STANDARD  QUESTION  13 

silver  bullion  plus  the  silver  dollars  held;  but  when  re- 
deemed by  silver,  the  treasury  notes  would  be  cancelled 
in  order  to  keep  the  amount  outstanding  no  greater  nor 
less  than  the  silver  bullion  plus  the  diminished  number 
of  silvw  dollars  held.  The  released  silver  dollars,  if  re- 
turned in  any  way  to  the  Treasury,  could  then  become 
the  basis  of  additional  silver  certificates  (but  never  of 
treasury  notes).  This  explains  why  the  treasury  notes 
were  gradually  being  reduced  in  volume,  coincident  with 
an  increase  of  silver  dollars  and  silver  certificates. 

The  act  of  June  13,  1898  (the  Spanish  War  Loan  and 
Revenue  Act),  stimulated  this  process  by  the  following 
requirement  (sec.  34): 

That  the  Secretary  of  the  Treasury  is  hereby  authorized  and 
directed  to  coin  into  standard  silver  dollars  as  rapidly  as  the 
public  interests  may  require,  to  an  amount,  however,  of  not 
less  than  one  and  one-half  millions  of  dollars  in  each  month, 
all  of  the  silver  bullion  now  in  the  Treasury  purchased  in  accor- 
dance with  the  provisions  of  the  act  approved  July  14,  1890, 
.  .  .  and  said  dollars,  when  so  coined,  shall  be  used  and  ap- 
plied in  the  manner  and  for  the  purposes  named  in  said  act. 

Then  the  act  of  March  14,  1900,  specified  that  as  fast 
as  silver  dollars  were  coined  under  the  foregoing  laws, 
the  secretary  should  (sec.  5): 

retire  and  cancel  an  equal  amount  of  Treasury  notes  whenever 
received  into  the  Treasury,  either  by  exchange  in  accordance 
with  the  provisions  of  this  act  or  in  the  ordinary  course  of 
business,  and  upon  the  cancellation  of  Treasury  notes  silver 
certificates  shall  be  issued  against  the  silver  dollars  so  coined. 

In  this  way  that  law  brought  about  the  cancellation 
of  treasury  notes  without  waiting  for  the  former  process 
of  redemption  by  silver,  thus  hastening  the  conversion 
of  treasury  notes  into  silver  certificates.    The  only  ad- 


14  BANKING  PROGRESS 

vantage  to  be  gained  from  this  action  was  the  final  dis- 
appearance of  one  of  the  too  many  kinds  of  money  which 
make  up  our  circulation. 

When  that  law  came  into  force  there  were  onlj'  $86,- 
776,000  treasury  notes  outstanding,  supported  by  bul- 
lion costing  $77,402,692,  plus  9,373,308  silver  dollars. 
The  number  of  ounces  of  fine  silver  uncoined  at  that 
date  was  about  85,550,000.  Consequently,  mstead  of 
*  1 55 ,000,000  in  treasury  notes,  there  would  be  about 
.00,000,000  in  silver  dollars  when  conversion  had  been 
completed,  or  an  increase  of  not  less  than  45,000,000 
dollars.  This  increased  volume  of  silver  dollars  would 
raise  the  total  issue  (including  the  378,000,000  dollars 
coined  under  the  act  of  1878)  to  about  578,000,000  dol- 
lars. For  the  maintenance  of  this  vast  sum  at  a  parity 
with  gold,  when  each  silver  dollar  was  then  actually 
worth  only  about  47  cents,  there  was  absolutely  no 
method  of  direct  redemption  m  gold.  And  the  act  of 
March  14,  1900,  gave  no  new  provisions  whatever  to 
accomplish  this  end,  or  to  support  its  windy  and  virtuous 
order  to  the  secretary  to  maintain  the  parity.  So  far  as 
any  new  power  was  given  him  to  carrj-  out  the  purpose, 
Congress  might  as  well  have  ordered  the  secretary  to  see 
that  every  citizen  of  the  United  States  should  have  blue 
eyes. 

§  6.  It  will  be  noticed  that  all  the  machinery  for  a 
gold  reserve,  its  increase  to  $150,000,000,  its  replenish- 
ment from  sales  of  bonds,  etc.,  had  to  do  solely  with  pro- 
tection to  the  United  States  notes  and  treasury  notes  of 
1890.  Hence,  when  the  latter  have  ceased  to  exist,  the 
gold  reser\^e  wall  remain  only  for  the  government  paper, 
with  nothing  in  reserve  for  our  token  silver.  The  omi- 
nous feature  of  this  arrangement  is  the  evident  intention 


THE  STANDARD  QUESTION  15 

to  regard  the  United  States  notes  as  a  permanent  part  of 
the  circulation.  No  suggestion  whatever  is  made  as  to 
the  future  retirement  of  any  portion  of  this  form  of  our 
money.  That,  it  is  clear,  must  be  reserved  for  future 
reforms. 

But  although  the  act  of  1900  gave  us  no  firmer  hold 
on  the  gold  standard,  and  did  nothing  to  remove  the 
United  States  notes,  it  has,  indeed,  secured  to  us  a  re- 
form which,  in  possibilities  of  safety  in  the  future,  wholly 
outweighs  any  other  feature  of  the  act.  No  one  who  has 
watched  carefully  the  origins  of  our  paper-money  de- 
lusions will  fail  to  realize  how  dangerous  was  the  con- 
fusion in  the  minds  of  our  legislators  in  the  past  between 
the  monetary  and  the  fiscal  functions  of  the  Treasury. 
It  was  this  confusion  which,  in  1862,  led  to  borrowing 
in  the  form  of  demand  obligations  to  be  used  as  money; 
to  a  depreciation  of  the  standard  of  prices;  to  the  de- 
struction of  our  credit  in  the  loan  market;  to  the  appear- 
ance of  speculation  and  unsettled  business  conditions — 
and  all  the  evils  of  a  fluctuating  currency.  Since  the 
resumption  of  specie  payments  in  1879,  the  gold  reserve 
had  been  a  part  of  the  general  fund  applicable  to  fiscal 
purposes  in  cases  of  deficit  as  well  as  to  the  redemption 
of  our  paper  money.  For  this  reason  we  got  into  serious 
trouble  when  deficits  used  up  the  gold  reserves,  because 
fiscal  operations  took  immediate  effect  on  the  reserves 
protecting  the  character  of  our  standard  of  prices  and 
contracts.  No  mere  question  of  revenue  and  expendi- 
ture of  the  general  treasury  should  ever  be  permitted  to 
have  such  an  influence  on  our  standard  that  business 
could  be  thereby  seriously  crippled.  It  is  such  an  anom- 
alous situation  as  this  which  we  are  happy  to  say  has 
been  made  impossible  by  the  distinct  separation  of  the 
funds  used  for  reserves  behind  the  government  paper 


16  BANKING  PROGRESS 

from  other  cash  in  the  hands  of  the  State.  This  appeared 
in  the  new  form  of  treasury  statements.  In  the  years 
to  come  nothing  we  have  accompHshed  ought  to  have 
done  more  than  this  one  provision  to  clarify  the  public 
mind  as  to  the  true  status  of  our  paper  money,  and  to 
save  us  from  stupid  blundering.  While  this  part  of  the 
act  excited  little  comment  in  the  press,  it  was  of  first 
importance  as  a  piece  of  positive  legislation.  This  one 
measure  would  alone  have  made  the  act  prominent  in 
the  history  of  monetary  legislation  since  the  Civil  War. 
But  we  again  relapsed  into  much  the  same  diflficulty  with 
the  Federal  Reserve  Act  during  the  war  (see  Chapter  XI). 
The  regulations  by  which  the  gold  reserve  for  govern- 
ment paper  is  to  be  maintained,  and  the  details  of  re- 
demption, are  doubtless  clumsy,  and  drawn  in  such  a 
way  as  to  escape  political  attack;  but  there  is  little  reason 
to  believe  that  they  will  not  work  out  successfully  in 
practice.  Certainly  the  redeemability  of  the  United 
States  notes  and  the  treasury  notes  of  1890  was  provided 
for  beyond  peradventure  in  the  permission  to  sell  bonds 
to  protect  the  gold  reserve.  But  the  separation  of  the 
issue  and  redemption  departments  from  the  general 
treasury  funds  makes  entirely  clear  that  no  gold  in  the 
former  can  ever  be  used  in  the  indirect  or  direct  redemp- 
tion of  silver  dollars ;  and  that  the  character  of  the  silver 
circulation  will  depend  wholly  upon  the  composition  of 
the  free  treasury  balance.  If  gold  should  not  readily 
come  in  for  revenue,  or  if  redundant  silver  or  other  cur- 
rency should  be  paid  in  instead,  the  free  balance  would 
more  quickly  than  of  old  indicate  the  difficulty  of  main- 
taining our  large  silver  circulation  at  a  parity  with  gold. 

§  7.     This  act,  however,  was  not  concerned  only  with 
the  standard.     It  also  touched  on  the  subject  of  banking. 


THE  STANDARD  QUESTION  17 

The  sections  of  the  law  relating  to  banking,  however, 
may  be  dismissed  in  a  few  words,  because  the  changes 
proposed  were  unimportant.  The  reduction  in  the  tax 
on  circulation,  and  the  increase  in  the  amount  of  notes 
issued  by  banks  to  100  per  cent  of  the  value  of  the  bonds, 
had  some  influence  in  expanding  the  circulation. 

The  refunding  provisions,  however,  were  of  an  impor- 
tant character.  They  were  important  because,  in  order 
to  serve  a  political  end,  one  of  the  generally  accepted 
principles  of  finance  was  violated.  There  can  be  no 
doubt  that  the  extension  of  the  term  of  the  new  bonds 
to  thirty  years  had  only  political  considerations  behind 
it.  It  is  almost  inconceivable  in  a  modern  community 
that  a  State  should  put  its  bonds  in  a  form  where  they 
cannot  be  paid  off  within  a  reasonable  period.  After  the 
extended  2s  were  paid  off  (a  process  then  going  on),  and 
after  all  the  old  bonds  were  refunded  into  the  new  loan, 
our  national  debt  could  not  be  reduced  (except  by  pur- 
chase in  the  open  market)  before  the  4s  of  1925  matured. 
So  flagrant  an  abuse  of  sound  finance  could  be  explained 
only  on  the  supposition  that  a  supply  of  national  bonds 
would  be  assured  for  a  generation  to  come  in  quantity 
sufficient  for  the  security  of  the  national  bank  circulation. 
Such  was  the  adroit  move  by  which  the  Senate  leaders 
supposedly  succeeded  in  shelving  for  decades  the  demand 
for  an  elastic  bank  currency  based  upon  commercial 
assets.  And  if  the  refunding  measure  released  a  consid- 
erable sum  from  the  Treasury  in  payment  of  premiums, 
and  caused  an  enlargement  of  the  banking  circulation, 
it  would  be  supposed  to  ease  the  money  market  during 
a  presidential  year,  aid  in  the  "prosperity"  argument, 
and  assist  in  the  political  purposes  of  the  party  in  power. 
In  general,  it  can  be  said  that  the  new  measure  did  not 
add  anything  of  value  to  the  machinery  by  which  the 


18  BANKING  PROGRESS 

banks  were  enabled  to  adjust  the  supply  of  currency 
automatically  to  the  needs  of  the  public.  Many  small 
banks,  and  some  large  ones,  would  no  doubt  be  established, 
or  come  into  the  system,  but  after  that  increase,  the 
rigidity  of  the  old  system  would  remain  with  all  its  well- 
known  characteristics. 


CHAPTER  II 
ELASTICITY  OF  BANK-ISSUES 

§  1.  In  the  United  States  after  the  long  struggle  for 
a  stable  standard  of  prices — ranging  over  the  greenback 
and  silver  campaigns  from  1874  to  1896 — the  attention 
of  intelligent  reformers  seemed  to  have  centred  on  ob- 
taining an  elastic  currency.  Elasticity  meant,  of  course, 
the  power  to  contract  as  well  as  to  expand  according  to 
the  needs  of  trade  and  credit.  Although  the  tremendous 
losses  from  the  panic  of  1893,  due  to  the  fear  of  a  silver 
standard,  directly  led  to  the  legislation  on  the  standard 
in  1900,  there  was  running  through  all  minds  in  the 
same  years,  mingling  with  the  discussion  on  the  standard, 
an  accompaniment  of  deep  discontent  regarding  the  con- 
dition of  our  paper  circulation,  its  safety,  and  especially 
its  flexibility.  It  was  not  then  perceived  that  the  pivotal 
matter,  underneath  all  questions  of  paper  money  and 
its  elasticity,  was  a  flexible  working  of  credit.  It  was  then 
believed  that  our  paper  currency,  whether  issued  by  the 
government  or  by  the  banks,  if  properly  conditioned, 
would  provide  all  the  elasticity  needed  by  a  good  currency 
system.  Indeed,  the  power  to  issue  notes  was  regarded 
by  most  pubhc  men  as  the  central  point  of  currency 
philosophy.  If  the  government  should  retain  the  con- 
trol over  paper  issues,  according  to  some  persons,  credit 
and  prices  would  be  under  control.  Or,  if  banks  were  to 
be  allowed  to  issue  notes,  all  legislation  should  lay  em- 
phasis on  these  notes,  their  quantity,  their  relation  to  the 
bank's  capital,  and  their  safety;  yet  all  the  while,  the 
banks,  through  their  credit  operations,  carried  out  by 

19 


20  BANKING  PROGRESS 

checks  drawn  on  deposits,  were  exercising  a  currency 
function  far  and  away  more  extensive  and  important 
than  any  performed  by  paper  money.  In  the  evolution 
of  our  thinking  on  money  and  credit  an  understanding 
of  these  latter  operations  did  not  early  come  to  the  front. 
Meantime,  our  minds  were  mainly  occupied — as  they 
had  been  in  fact  since  early  in  the  previous  century — 
with  questions  as  to  the  issue  of  notes.  Fundamental 
to  the  settlement  of  these  problems  was  a  weighing  of 
the  relative  value  of  a  system  of  governmental  issues  in 
contrast  with  that  of  bank-issues.^  That  we  should, 
because  of  inherited  prejudices  and  the  accidental  legis- 
lation of  the  Civil  War,  in  spite  of  opposing  experience  in 
Great  Britain  and  on  the  Continent,  have  clung  to  the 
issue  of  governmental  paper  (although  limited  in  amount) 
even  to  the  present  day,  and  after  the  passage  of  the 
Federal  Reserve  Act,  is  a  curious  case  of  persistency  in  a 
dangerous  expedient. 

Nevertheless,  even  though  the  greenback  has  by  tacit 
acquiescence  remained  as  a  rigid  part  of  our  currency, 
there  has  arisen  without  debate  and  almost  uncon- 
sciously a  wide-spread  sentiment  in  favor  of  bank-issues. 
This  opinion  grew  no  doubt  because  of  a  belief  that  the 
well-recognized  inelasticity  of  the  national  bank  notes 
could  be  removed. 

§  2.  It  is  well  here  briefly  to  recall  the  reasons  why 
the  old  national  bank  notes,  before  the  enactment  of 
the  Federal  Reserve  Act,  were  signally  inelastic;  for  they 
are  typical  of  any  system  of  issues  secured  by  bonds. 

First,  these  notes  were  inelastic  because  they  could 
not  be  readily  expanded  to  meet  the  needs  of  any  sudden 
demand.     The  method   of   their   issue  is   well   known: 

*  CJ.  Laughlin,  Money  and  Prices  (1919),  chap.  X. 


ELASTICITY  OF  BANK-ISSUES  21 

The  national  banks  could  take  out  new  circulation  only 
by  securing  and  depositing  United  States  bonds  with 
the  comptroller  of  the  currency.  Since  these  notes 
were  printed  from  separate  plates  for  each  bank,  the 
sending  in  of  bonds,  the  printing  of  the  notes  in  Wash- 
ington, their  shipment  to  the  bank,  and  the  signing  of 
the  notes  by  the  respective  bank  officials,  caused  more  or 
less  delay  before  the  notes  were  ready  to  be  issued.  At 
least  three  weeks  were  thus  consumed.  This  delay  was 
such  that,  unless  foreseen,  bank-notes  could  seldom  be 
obtained  quickly  enough  to  meet  a  sudden  demand  for 
cash. 

Moreover,  the  motive  for  issuing  notes  based  on  bonds 
is  not  the  needs  of  business,  but  the  possibihty  of  profit 
to  the  bank.  The  prospect  of  profit,  however,  is  compli- 
cated with  many  considerations  outside  the  control  of 
the  bank.  The  price  which  must  be  paid  for  bonds 
necessarily  affects  the  wnllingness  of  the  banks  to  issue 
notes;  and  yet  in  past  years  the  quantity  and  kind  of 
government  bonds  available,  and  consequently  their 
price,  have  varied  greatly.  The  prices  of  bonds  may 
fluctuate  either  because  of  changes  in  the  credit  of  the 
government,  or  changes  in  the  current  rate  of  interest. 
If  our  credit  improves,  bonds  paying  more  than  a  normal 
rate  rise  in  value;  or,  other  things  remaining  the  same, 
a  fall  in  the  market  rate  of  interest  will  cause  a  rise  in 
the  price  of  bonds  having  a  fixed  return.  Moreover,  the 
term  for  which  a  bond  runs  affects  its  price:  as  a  bond 
approaches  maturity  it  will  drop  to  par;  if  yielding  more 
than  the  market  rate  of  interest  a  long-term  bond,  not 
paying  as  much  as  a  short-term  bond,  might  command 
a  high  premium. 

A  bank  makes  its  profit  by  the  discount  on  a  loan.  If 
a  borrower,  however,  wishes  bank-notes,  the  profit  to 


22  BANKING  PROGRESS 

the  bank  will  be  affected  by  the  expense  of  issuing  notes; 
that  is,  the  gain  from  the  market  rate  on  the  loan  would 
be  affected  by  the  interest  paid  on  the  securities  required 
to  obtain  the  notes.  A  high  market  rate  of  interest  tends 
to  prevent  the  issue  of  notes  secured  by  bonds.  Instead  of 
investing  in  these  bonds,  by  lending  their  funds  direct  to 
borrowers  who  ask  only  a  deposit-account  and  the  right 
to  draw  on  it  with  checks,  a  bank  can  earn  larger  profits. 

Also,  until  1900,  notes  to  only  90  per  cent  of  the  par 
value  of  the  bonds  could  be  issued.  That  is,  taking  $100 
out  of  the  cash  resources  of  a  bank  in  order  to  obtain 
$90  (and  later  $100)  in  their  own  notes  meant  that  giv- 
ing credit  to  those  wishing  a  note-liability  (instead  of  a 
deposit-liabihty)  crippled  the  power  of  a  bank  to  earn 
profits.  Hence  in  the  years  1883-1893  there  was  a 
marked  decline  in  the  national  bank  circulation.  There- 
after, from  $178,713,692  in  1893,  it  grew  to  $353,742,- 
186  in  1901,  and  to  $759,157,906  in  1913  (the  year  of  the 
Federal  Reserve  Act). 

Changes  in  conditions  outside  the  control  of  the  banks 
produce  an  effect  on  tlieir  profits  and  on  the  amount  of 
the  circulation  issued.  Experience  has  shown  that  a 
system  of  notes  secured  by  bonds  is  inconsistent  with  the 
automatic  adjustment  of  the  quantity  of  the  circulation 
to  the  demands  of  the  public  and  the  needs  of  trade. 
When  the  demand  for  loans  is  great  and  the  market  rate 
of  interest  is  high,  there  is  little  profit  in  issuing  notes; 
in  short,  when  the  demand  may  be  urgent,  the  supply 
may  not  be  forthcoming. 

On  the  other  hand,  if  the  country  is  suffering  from 
business  depression,  if  funds  are  accumulating  in  the 
banks,  and  if  the  market  rate  of  interest  is  low  because 
there  are  few  opportunities  of  profitably  employing  cap- 
ital, then  it  would  be  natural  to  expect  the  banks  to  use 


ELASTICITY  OF  BANK-ISSUES  23 

superabundant  funds  in  buying  safe  bonds  of  a  low  rate 
of  interest.  Therefore,  at  a  time  when  the  demand  for 
loans  is  slight  and  the  rate  of  discount  is  low,  it  would  be 
easy  for  the  banks  to  invest  in  bonds  and  thereby  obtain 
notes.  In  short,  when  there  is  no  demand,  the  supply 
is  easily  obtained.  It  needs  no  further  comment,  conse- 
quently, to  see  that  such  a  system  of  note-issues  works 
at  cross  purposes  with  the  needs  of  the  public.  With  a 
deposit  of  bonds  for  security  of  notes,  there  is  hkely  to 
be  no  supply  of  notes  at  a  time  when  most  needed  and  an 
abundant  supply  when  least  needed.^ 

Moreover,  a  bond-secured  circulation  is  limited  by 
the  supply  of  available  bonds  having  the  circulation 
privilege  (z.  e.,  the  right  to  be  deposited  to  secure  notes). 
The  maximum  of  such  notes  is  thus  restricted,  not  by 
the  needs  of  business,  but  by  the  total  supply  of  bonds. 
In  the  years  before  the  European  War,  when  our  national 
debt  was  beirig  reduced,  this  supply  of  bonds  was  so 
limited  that  the  2  per  cent  bonds  possessing  the  circula- 
tion privilege  were  thereby  given  a  value  far  above  their 
investment  price.  Also,  the  practice  of  the  Treasury  in 
requiring  bonds  to  be  deposited  by  banks  to  the  amount 
of  government  funds  received  created  an  additional  de- 
mand for  bonds.  Thus  at  the  very  time  when  there  was 
a  large  Treasury  surplus  there  was  a  tendency  to  limit 
the  bonds  available  for  note-issues;  and  yet  this  was  a 
time  of  general  prosperity  when  a  demand  on  the  banks 
for  loans,  and  incidentally  for  currency,  would  be  strong. 
Of  course,  since  the  large  issue  of  government  bonds 
during  the  European  War,  there  could  be  no  lack  of  bonds 
for  this  purpose,  if  it  were  a  desirable  one  in  itself. 

^  See  Report  of  the  Monetary  Commission  of  1898,  p.  228,  and  also  sees.  133-136, 
103-110.  Also  see  Banking  Reform,  National  Citizens  League  (1912),  ohapa. 
IV  and  VIII. 


24  BANKING  PROGRESS 

In  the  second  place,  national  bank  notes  were  inelastic 
because  their  contraction  was  even  more  delayed  than 
their  expansion.  Elasticity,  as  already  said,  implies  two 
conditions:  (1)  immediate  expansion  whenever  there  is 
an  increased  demand  for  currency;  and  (2)  prompt  re- 
tirement as  soon  as  the  need  for  it  has  passed.  The 
proper  supply  needed  by  the  public  is  always  automati- 
cally adjusted  to  the  need,  if  there  is  a  system  of  easy 
and  immediate  redemption.  In  short,  immediate  re- 
demption necessarily  secures  not  only  the  parity  of  the 
notes  but  the  impossibility  of  a  superabundant  circula- 
tion. 

The  redemption  of  national  bank  notes  was  imperfect. 
The  very  uniformity  and  safety  of  these  notes  consti- 
tuted the  reason  why  they  would  not  be  sent  in  for  re- 
demption by  any  one  else  than  the  issuing  bank.  Its 
circulation  being  out  in  all  parts  of  the  country,  a  bank 
could  seldom  get  hold  of  its  own  notes.  Only  as  they 
happened  to  be  sent  in  to  the  one  redemption  agency  in 
Washington  could  a  bank  secure  a  return  of  its  own  notes. 
To  withdraw  its  circulation,  a  bank  could  deposit  lawful 
money  with  the  Treasury  to  the  amount  of  the  notes  to 
be  retired,  and  thereupon  take  away  the  bonds  kept  for 
their  ultimate  redemption.  This  "doomed  circulation" 
remained  out  in  the  hands  of  the  public  until  they  were 
either  sent  in  by  other  banks  or  became  so  mutilated 
that  they  would  appear  at  the  redemption  agency  to  be 
exchanged  for  fresh  notes.  Therefore,  not  only  was  the 
withdrawal  of  notes  unreasonably  delayed,  but  the  con- 
traction was  accomplished  only  by  the  hiding  away  in 
the  Treasury  of  an  equivalent  sum  of  lawful  money. 
Moreover,  by  the  act  of  July  22,  1882,  no  more  than 
$3,000,000  could  be  withdrawn  in  any  one  month;  on 
March  4,   1907,  this  amount  was  fixed  at  $9,000,000. 


ELASTICITY  OF  BANK-ISSUES  25 

Consequently,  when,  in  times  of  an  urgent  demand  for 
notes,  a  bank  was  induced  to  issue  notes  temporarily,  it 
knew  that  it  would  be  practically  impossible  to  with- 
draw them  until  long  after  the  emergency  had  passed. 
Sometimes  a  bank  found  it  had  outstanding  all  the  notes 
it  could  care  for,  and  when  asked  for  notes  by  its  cus- 
tomers could  get  them  only  by  borrowing  them  from 
banks  (usually  large  city  banks)  which  had  not  fully 
used  their  privilege  of  issue. 

So  far  as  the  actual  use  of  money  is  concerned,  when 
passed  from  hand  to  hand,  there  are  seasonal  variations 
in  the  demand,  arising  from  methods  of  doing  business, 
and  especially  from  the  ebb  and  flow  of  industrial  activ- 
ity at  different  seasons.  Thus  there  are  varying  demands 
for  a  medium  of  exchange  for  pay-rolls,  payment  of 
dividends  on  stocks  and  bonds  at  quarterly  or  semi- 
annual periods,  or  the  marketing  of  the  crops  in  the 
autumn.  For  such  purposes  the  cliaracteristic  of  ex- 
panding and  contracting  with  seasonal  needs  was  regarded 
as  very  important.  Of  course,  the  national  bank  notes 
lacked  such  elasticity.  For  many  years,  while  the  at- 
tention of  currency  reformers  was  concentrated  on  elas- 
ticity of  the  currency,  the  Canadian  and  Scotch  banking 
system  was  highly  praised  by  contrast  with  our  own  in 
this  respect.  It  was  found  that  the  life  of  a  national 
bank  note,  due  to  the  extreme  slowness  of  redemption, 
was  about  two  years,  while  that  of  a  Canadian  bank  note 
was  only  thirty  days,  and  of  a  Scotch  note  eighteen 
days.^ 

The  sum  of  the  whole  matter  is  that  under  the  existing  system 
of  bank-notes  based  upon  government  bonds,  normal  and 
authentic  expansion  and  contraction  of  the  currency,  in  re- 
sponse to  needs  of  trade,  is  flatly  impossible.     The  currency 

*  See  Report  of  Monetary  Commission  of  1898,  sees.  207-225. 


26  BANKING  PROGRESS 

supply  may  be  greatly  enlarged  in  the  dull  midsummer  months 
and  suddenly  contracted  when  the  active  autunm  business 
season  begins.  It  may  increase  rapidly  at  a  time  when  trade 
reaction  has  reduced  to  a  minimum  the  necessities  for  even  the 
existing  bank-note  supply,  or  it  may  be  as  rapidly  reduced 
when  large  harvests,  full  employment  of  labor,  and  active 
hand-to-hand  use  of  currency  most  need  a  larger  circulating 
medium.  That  there  is  no  remedy  for  this  abnormal  situation, 
except  the  substitution  of  some  other  system  for  that  which 
prescribes  the  United  States  Government  bond  as  a  basis  for 
bank-note  issues,  every  economist  at  all  familiar  ^ith  the 
question  agrees.^ 

§  3.  This  matter  of  the  inelasticity  of  our  currency 
was  probably  overemphasized.  It  was  not  realized  that 
it  was  only  one  phase  of  a  larger  question.  It  was,  of 
course,  true  that  a  certain  marginal  elasticity  on  the 
general  amount  of  our  circulation  was  quite  important. 
Nevertheless,  it  is  now  clearly  seen  that  a  few  years  ago, 
under  a  demand  for  an  elastic  currency,  it  was  supposed 
that  issues  of  notes  would  be  a  remedy  for  the  disasters 
of  a  financial  panic.  Such  a  point  of  view  ignored  the 
deeper  and  wider  question  of  credit  and  the  lending  power 
of  the  banks.  In  a  time  of  panic  what  a  hard-pressed 
business  man  wanted  was  a  loan,  and,  if  this  was  granted, 
he  found  a  perfectly  elastic  medium  of  exchange  at  all 
times  in  the  deposit-currency  (i.  e.,  checks  drawn  on  de- 
posit-accounts). The  resort  to  the  issue  of  clearing- 
house certificates  in  times  of  stress  was  not  made  to 
furnish  a  medium  of  exchange,  but  to  make  loans  possible. 
The  matter  of  elastic  bank-notes,  although  necessary, 
was  certain  to  be  overshadowed  sooner  or  later  by  the 
demand  for  a  better  organization  of  credit.  One  of  the 
important  objections  to  the  old  national  banking  system 

1  A.  D.  Noyes,  History  of  the  National  Bank  Currency,  p.  20  (issued  by  Na- 
tional Monetary  Commission). 


ELASTICITY  OF  BANK-ISSUES  27 

was  that  the  bond  requirement  really  limited  the  lending 
power  of  a  national  bank.  To  see  these  things,  however, 
there  was  needed  a  long  education  and  a  slow  evolution 
in  our  thinking  about  banks.  Banking  progress  did  not 
come  at  once.  The  greater  need  of  the  elasticity  of 
credit,  which  was  later  brought  about  by  the  Federal 
Reserve  Act  of  1913,  was  not  then  understood. 

It  was  the  experience  with  the  national  bank  notes 
(all  other  forms  of  our  paper  being  rigidly  inelastic)  that 
forced  attention  on  remedial  measures  aiming  at  elas- 
ticity in  general.  Then  began  the  agitation  against  a 
bond-secured  system  of  note-issues  and  for  some  method 
of  safely  securing  the  notes  by  commercial  assets  which 
has  since  gone  on  to  its  final  consummation  in  the  Federal 
Reserve  Act.  The  fear  of  undue  expansion  and  of  lack 
of  security  behind  such  notes  produced  no  little  timidity 
in  venturing  on  new  experiments.  This  point  of  view 
accounts  for  the  constant  endeavor  in  all  schemes  to  re- 
late the  amount  of  issues  to  a  percentage  of  the  capital 
of  the  issuing  bank;  yet  the  issues  are  in  truth  func- 
tionally related  not  to  the  capital  but  to  the  assets  of  the 
bank. 

It  is  interesting  to  record  that  the  first  definite  pro- 
posal to  use  commercial  assets  came  from  the  American 
Bankers'  Association  in  1894,  and  was  known  as  the 
"Baltimore  Plan."  Although  it  did  not  come  to  fruition, 
it  was  important  in  blazing  the  way  for  later  possibilities. 

In  brief,  it  was  proposed  to  allow  the  national  banks 
under  federal  supervision  to  issue  circulating  notes  se- 
cured by  (1)  a  first  lien  upon  the  assets  of  the  issuing  bank, 
(2)  the  double  liability  of  shareholders,  (3)  the  5  per 
cent  redemption  fund,  and  (4)  a  5  per  cent  guaranty 
fund.  In  case  of  failed  banks  the  guaranty  fund  could 
be  replenished,  if  necessary,  by  use  of  the  prior  lien.    It 


28  BANKING  PROGRESS 

will  be  observed  that  the  noteholder  was  given  a  prior 
claim  over  the  depositor,  thus  retaining  the  intent  of  the 
former  method  of  segregating  assets  in  the  form  of  bonds 
to  protect  the  notes.  In  addition,  the  amount  of  notes 
was  restricted  and  taxed  to  insure  their  retirement  when 
the  need  for  their  issue  had  disappeared.  To  50  per  cent 
of  the  paid-up,  unimpaired  capital  of  the  bank  the  tax 
on  the  notes  was  3^  of  1  per  cent;  and  additional  issues 
were  allowed  up  to  75  per  cent  of  the  capital,  but  subject 
to  a  much  heavier  tax.  Thus  the  maximum  issue  per- 
mitted was  75  per  cent  of  the  capital.  This  was  a  seri- 
ous check  on  elasticity. 

§  4.  How  this  proposal  was  received  at  the  time  and 
the  attitude  toward  it  belongs  to  our  monetary  his- 
tory. The  Baltimore  Plan,  thus  presented,  dealt  solely 
with  the  function  of  note-issues  of  banks,  totally  disre- 
garding the  two  other  important  functions,  namely,  de- 
posit and  discount.  It  did  not  propose  to  modify  ex- 
isting law  with  regard  to  the  immediate  redemption  of 
bank-notes.  The  redemption  fund  of  5  per  cent  in 
Washington  and  the  usual  requirements  for  redeeming 
notes  at  their  counters  were  to  remain  imtouched.  The 
plan  proposed  a  radical  and  drastic  change  in  the  pro- 
visions of  the  existing  law  as  to  the  ultimate  redemption 
of  national  bank  notes.  At  that  time  the  ultimate  re- 
demption and  security  for  bank-notes  were  United  States 
bonds.  A  bank  could  then  issue  notes  up  to  90  per  cent 
of  the  par  value  of  the  bonds.  The  Baltimore  Plan  in- 
stead proposed  a  5  per  cent  guaranty  fund  held  by  the 
government,  then  a  prior  lien  on  all  the  assets  of  the  bank, 
and  if  this  were  insufficient,  then  on  the  stockholders' 
liabilities. 

The  security  to  the  note-issues  was  large  and  unques- 
tionable.    The  prior  lien  on  the  assets  is  not  really  un- 


ELASTICITY  OF  BANK-ISSUES  29 

derstood.  As  is  proper,  it  gave  the  noteholder  a  Hen 
before  the  depositor  on  all  the  assets.  The  limitation  of 
the  amount  of  issues  to  50  or  75  per  cent  of  the  unim- 
paired paid-up  capital  was  a  mere  formality,  so  far  as 
security  goes.  There  is  no  measure  whatever  of  the  as- 
sets of  a  bank  in  comparing  them  with  its  paid-up  cap- 
ital. The  item  of  loans  may  be  enormously  larger  than 
capital,  and  that  is  so  in  every  strong,  well-trusted  bank. 
For  example,  some  years  ago  the  Chemical  Bank  of  New 
York  had  a  capital  of  $300,000,  but  loans  of  perhaps 
$15,000,000  or  $20,000,000;  and  the  relation  of  capital 
to  assets  was  much  the  same  in  such  a  bank  as  the  First 
National  Bank  of  Chicago.  Therefore  the  limitation  of 
issues  to  a  certain  percentage  of  capital  gives  a  security 
in  assets  out  of  all  proportion  merely  to  capital. 

Secretary  Carlisle  modified  the  Baltimore  Plan  in  favor 
of  greater  security  to  noteholders.  He  proposed,  first,  a 
deposit  of  30  per  cent  of  the  circulation  in  legal  money 
with  the  government;  then,  second,  the  safety  fund  of 
5  per  cent;  third,  a  requirement  upon  all  other  banks  to 
fill  up  deficiencies  in  these  two  funds  of  any  failed  bank; 
fourth,  a  lien  upon  all  the  assets,  and,  fifth,  a  further  lien 
upon  the  stockholders'  liability. 

Both  these  plans  mentioned  agreed  in  limiting  the  issues 
to  a  percentage  of  50  or  75  per  cent  of  the  paid-up  cap- 
ital. Hitherto  we  had  been  complaining  of  the  inelastic 
character  of  our  "greenbacks"  as  a  reason  for  their  re- 
tirement; but  in  the  new  plans  it  was  made  impossible 
to  issue  more  notes  than  a  certain  percentage  of  bank 
capital.  But  national  bank  capital  is  not  an  elastic 
thing.  Indeed,  it  had  not  changed  greatly  in  years.  In 
1875  it  was  $504,000,000,  in  1893  it  had  increased  only 
to  $678,000,000;  while  the  total  amount  of  our  circula- 
tion increased  from  $754,000,000  in  1875  to  about  $1,600,- 
000,000  in  1893;  and  population  had  in  the  same  period 


30  BANKING  PROGRESS 

grown  from  41,000,000  to  66,000,000.  We  see  therefore 
that  the  new  scheme  set  up  an  melastic  barrier  of  bank 
capital,  and  determined  the  amount  of  the  issues  by 
taking  a  certain  percentage  of  that  inelastic  capital. 
To  this  extent  the  new  schemes,  while  to  be  approved  in 
general,  were  defective. 

Most  of  the  objections  made  against  the  Baltimore 
Plan  and  in  the  general  discussion  of  currency  at  that 
time  were  based  upon  the  insufficiency  of  the  supply  of 
gold,  as  if  that  had  caused  a  fall  of  prices,  and  the  need 
of  more  money.  From  1850  to  1875  there  had  been  pro- 
duced as  much  gold  as  was  produced  from  the  discovery  of 
America  in  1492  to  1850 — three  hundred  and  fifty-seven 
years.  In  forty  years  we  had  produced  about  $5,300,- 
000,000  of  gold  as  against  the  production  before  1850  of 
about  $3,000,000,000.  Judging  from  the  statistics  of 
Adolph  Soetbeer,  the  German  statistician,  on  the  product 
of  gold  and  silver,  the  difficulty  is  to  discover  what  had 
become  of  the  gold.  In  the  last  statement  of  the  Mint 
preceding  1894  of  the  amount  of  gold  in  all  the  currencies 
of  the  world,  even  including  such  countries  as  Japan,  the 
total  amount  of  gold  in  use  as  money  amounted  to  about 
$3,500,000,000.  We  had  in  existence  in  1850  probably 
not  more  than  $2,000,000,000  of  gold.^  We  produced 
from  1850  to  1893,  $5,300,000,000  of  gold.  We  have 
difficulty  in  accounting  for  nearly  $1,800,000,000  of  gold 
that  we  cannot  find  in  the  currencies  of  the  world.  Since 
that  time  gold  has  gone  on  increasing.  There  is  more 
gold  to-day  in  the  circulation  of  the  world  than  there  has 
ever  been  at  any  time  in  history. 

§  5.    In  all  these  plans  we  were  really  aiming  to  pre- 
vent the  difficulties  experienced  in  1893,  when  we  re- 

1  See  Laughlin,  Money  and  Prices,  p.  86. 


ELASTICITY  OF  BANK-ISSUES  31 

sorted  so  largely  to  clearing-house  certificates.  Let  us 
see  just  what  took  place,  and  what  the  remedy  should  be. 
In  normal  times  before  a  panic  one  man  sells  his  goods 
expressed  in  terms  of  the  standard  money,  drawing  a  bill 
on  the  buyer  or  getting  his  note,  discounting  the  bills  or 
notes  at  his  bank,  getting  a  corresponding  deposit,  and 
paying  his  own  debts  by  drawing  checks  on  the  accounts 
thus  created.  And  so  with  others;  not  only  this  man, 
but  most  men  in  ordinary  business.  Not  more  than  5 
per  cent  of  wholesale  transactions  are  carried  on  by 
actual  money  used  as  a  medium  of  exchange.  Ninety- 
five  per  cent  of  the  goods  are  transferred  by  some  credit 
device;  the  media  of  exchange  are  not  wholly  money  but 
mainly  bills  and  checks.  These  latter  media  are  elastic, 
perfectly  elastic.  They  expand  exactly  in  proportion  to 
the  work  to  be  done. 

Then  what  happens  in  a  panic  like  that  of  1893.? 
Many  purchasers  have  obligations  maturing  at  fixed 
dates,  and  these  obligations  are  drawn  in  terms  of  the 
standard.  This  standard  is  gold.  Every  one  is  liqui- 
dating— selling  property,  stocks,  bonds,  in  order  to  get 
that  which  would  meet  these  obligations.  If  they  are 
not  met,  financial  failure  is  the  result.  Is  it  actual  coin 
or  bank-notes  that  every  one  needs  to  get  means  of  pay- 
ment ?  If  a  bank  will  lend  him  on  his  assets,  and  credit 
him  with  a  deposit,  he  is  safe.  So  long  as  a  bank  is 
able  and  willing  to  give  loans  on  assets,  that  is,  translate 
them  into  means  of  payment,  all  goes  well.  In  short, 
the  crux  of  the  whole  matter  is  traceable  to  the  banks. 
Can  they  expand  loans  sufficiently.?  Can  they  furnish 
all  the  means  of  payment  needed  to  enable  every  bor- 
rower having  bankable  goods  to  avoid  bankruptcy  when 
his  obligations  mature?  That  is  the  real  question.  Is 
there  elasticity  of  credit.?    In  a  panic  all  depends  on 


32  BANKING  PROGRESS 

the  answer  to  this.    Now,  how  does  the  elasticity  of 
note-issues  affect  the  situation  ? 

In  the  stress  of  a  panic,  what  is  needed  is  not  elas- 
ticity in  only  one  form  of  immediate  liability.  In  order 
to  enable  a  bank  to  loan,  and  so  stop  the  pressure,  it  is 
not  enough  to  have  an  elastic  limit  only  to  the  note- 
issues.  The  same  operation  can  be  carried  through  by 
a  deposit-account,  and  that  method  is  unrestricted  by 
law.  Indeed,  as  a  matter  of  fact,  the  largest  banks  make 
almost  no  use  of  their  note-liability,  and  use  only  the 
deposit-liability.  We  see,  therefore,  that  calling  atten- 
tion solely  to  the  elasticity  of  note-issues  in  the  Balti- 
more Plan  does  not  meet  the  whole  need.  Grant  that 
we  have  this  elasticity  of  note-issues,  we  shall  not  then 
be  able  to  meet  the  difficulties  which  will  inevitably 
arise  in  times  of  stringency  as  certainly  as  the  sun  rises 
in  the  east.  To  be  sure,  so  far  as  the  note-liability  is 
used  from  hand  to  hand  in  retail  and  small  transac- 
tions, it  is  well  to  have  the  issues  of  them  answer  promptly 
to  the  demand,  provided  safety  is  secured.  Then  both 
forms  of  immediate  liability — first,  deposit-credit,  and 
second,  note-issues — will  freely  respond  to  the  demand 
of  customers,  whenever  a  bank  can  lend  at  all.  But  it 
must  not  be  supposed  that  an  elastic  note-issue  is  a  uni- 
versal panacea  for  commercial  crises. 

§  6.  Here  it  may  not  be  amiss  to  refer  to  an  elemen- 
tary matter  in  banking.  A  bank  makes  its  profit  through 
buying  a  debt  due  in  the  future  by  giving  for  it  a  debt 
due  at  the  present  time.  That  is,  it  buys  a  note,  or  dis- 
counts a  bill,  say,  at  sixty  days,  with  collateral,  and  gives 
for  it  an  immediate  liability.  But  the  forms  in  which  a 
bank  gives  an  immediate  liability  are  two — which  one 
it  will  use  depends  on  the  customs  and  preferences  of  its 


ELASTICITY  OF  BANK-ISSUES  S3 

clientele.  First,  if  its  customers  are  engaged  in  large 
transactions,  as  in  a  city,  they  use  checks  almost  entirely. 
Therefore  the  bank  finds  that  making  a  deposit-account 
is  the  form  of  immediate  liability  which  will  be  generally 
used.  Second,  if  its  customers  always  pay  money  from 
hand  to  hand,  the  bank  finds  that  its  borrowers  ask  for 
that  form  of  immediate  liability  called  a  note-issue. 
Other  things  being  equal,  it  makes  no  difference  to  the 
profit  of  a  bank  which  is  used;  the  choice  between  the 
two  depends  upon  its  customers. 

It  seems  that  there  existed  in  this  country  a  most  ex- 
traordinary prejudice  against  banking.  It  must  be  based 
only  on  ignorance  of  what  the  banking  business  is. 
Therefore,  it  may  be  well  to  explain  in  brief  what  a  bank 
is.  It  is  not  different  in  essence  from  a  store  which  sells 
hardware  or  corn.  It  has  its  legitimate  function  in  busi- 
ness, just  as  any  shop  has.  It  buys  and  sells  something. 
It  gets  a  profit  because  it  buys  a  larger  debt  payable  in 
the  future  with  a  smaller  debt  payable  at  the  present 
moment.  Its  profit  is  there  and  nowhere  else.  It  does 
not  make  its  profit  on  the  issue  of  notes. ^ 

The  mental  confusion  on  monetary  subjects  is  too  often 
connected  with  a  failure  to  distinguish  between  the  pro- 
duction and  the  exchange  of  goods.  Money  is  a  machine 
by  which  goods  are  exchanged  after  they  are  produced. 
It  is  not  a  factor  of  production.  Increasing  the  amount 
of  money  does  not  increase  goods  in  other  forms.  By 
increasing  the  number  of  railways  between  Chicago  and 
St.  Paul,  the  number  of  bushels  of  corn  and  wheat  to  be 
carried  on  those  railways  is  not  increased.  An  increase 
of  the  means  of  transportation  does  not  increase  the 
quantity  of  goods  to  be  transported.    It  may,  indeed, 

*  For  a  full  discussion  on  this  point,  see  Report  of  Monetary  Commission  of 
1898,  sees.  103-110. 


34  BANKING  PROGRESS 

even  produce  the  opposite  effect;  an  excessive  transfer 
of  saved  wealth  into  railway  embankments  might  leave 
less  to  be  devoted  to  the  production  of  goods  seeking 
transportation.  The  case  is  precisely  the  same  with 
money.  Money  is  only  the  machinery  by  which  goods 
are  exchanged  against  one  another.  No  matter  how 
valuable,  it  is  not  wanted  as  a  medium  of  exchange  for 
its  own  sake,  but  for  what  it  will  buy.  We  do  not  eat 
or  drink  the  money  itself.  It  is  only  a  means  to  an 
end;  it  is  like  the  bridge  over  a  river — a  mechanism  by 
which  we  get  goods  from  one  shore  to  the  other.  To 
confuse  money  with  the  goods  it  transfers  is  like  failing 
to  distinguish  between  the  bridge  and  the  corn  and  pork 
which  pass  over  it.  To  suppose  that  coining  more  silver 
would  make  the  country  richer  is  to  suppose  that  the 
more  bridges  we  build  the  more  corn  and  pork  we  shall 
have;  or  that  the  more  railways  we  build  between 
Chicago  and  New  York,  the  more  goods  there  will  be 
to  pass  to  and  fro.  Once  the  real  work  performed  by 
money  is  apprehended,  the  fallacy  of  the  demand  for 
more  of  it  becomes  clearly  apparent.  It  is  an  insult 
to  the  intelligent  people  of  our  land  to  believe  that  they 
can  accept  and  maintain  a  doctrine  that  more  money 
creates  more  goods.  As  well  try  to  persuade  them  that 
the  more  shoe-strings  they  have  the  more  shoes  Ihey 
owTi.  Stupid  legislation  on  money  has  done  incalculable 
harm.  It  brought  us  the  panic  of  1893.  When  the 
chicken-hawk  of  monetary  idiocy  appears  in  the  sky,^ 
the  shy  chickens  of  capital  and  industry  scurry  to  cover. 
In  this  connection  it  may  be  well  to  point  to  one  of  the 
most  important  of  all  the  recommendations  in  Mr.  Car- 
lisle's message.  It  was  tucked  away  in  the  end  of  an 
innocent-looking  sentence  of  the  President's  message, 
but  was  more  fully  developed  by  the  secretary  himself. 


ELASTICITY  OF  BANK-ISSUES  35 

He  advocated  the  abolition  of  fixed  reserves  for  deposits. 
This,  with  the  proposal  to  withdraw  the  greenbacks, 
was  the  most  refreshing  talk  we  had  had  for  years.  To 
abolish  the  fixed  reserve  might  help  more  to  aid  bor- 
rowers in  a  panic  than  to  make  note-issues  elastic.  It 
touched  the  vital  relations  between  the  three  items  of 
most  importance  in  a  bank-account — the  loans,  the  de- 
posit-liability, and  the  reserves.  It  helped  to  allow  the 
bank  to  discount  at  the  most  critical  time.  As  our  laws 
then  stood  (1894),  they  aided  in  the  ruin  of  the  hard- 
pressed  borrower,  although  he  could  offer  good  collateral; 
at  the  very  moment  of  greatest  need  they  forbade  the 
bank  to  loan  at  the  risk  of  losing  its  charter.  At  the 
very  time  when  loans  were  most  needed  and  reserves 
were  at  the  legal  minimum,  banks  were  forced  to  cease 
discounting.  If  this  change  should  be  adopted,  how- 
ever, there  should  go  with  it  the  repeal  of  State  laws 
limiting  the  rates  of  discount. 

Nothing  in  the  proposals  for  currency  reform  is  more 
commendable  than  the  proposal  to  retire  the  United 
States  notes.  The  government  in  its  struggle  to  main- 
tain our  standard  by  selling  bonds  furnished  a  lesson 
which  should  not  pass  unheeded.  The  whole  matter 
was  undignified  and  unsafe.  Why  should  the  whole 
business  of  the  country  wait  on  the  fluctuating  politics 
of  a  Congress  chosen,  as  a  rule,  not  for  financial  experi- 
ence, but  for  political  prowess.'^ 

The  government  should  not  issue  notes,  for  many 
reasons:  First,  because  no  government  can  determine 
the  amoimt  of  issues  which  would  satisfy  business,  and 
which  should  be  automatic;  second,  because  there  is 
no  self-interest  to  prevent  overissues  and  maintain  con- 
vertibility (as  in  our  Civil  War);  third,  because  it  may 
any  hour  bring  us  all  the  evils  in  the  train  of  depreciated 


36  BANKING  PROGRESS 

paper,  speculation,  inflation,  thirst  for  "more  money," 
increase  of  government  burdens,  and  overwhelming  diffi- 
culties in  returning  to  solvency  again  by  contraction; 
fourth,  because  government  issues  are  inelastic;  and, 
fifth,  because  it  puts  the  government  in  the  dangerous 
position  of  trying  to  influence  and  control  prices  and  the 
money  markets.  These  are  reasons  enough  for  the  with- 
drawal of  the  United  States  notes.  But  there  should  be 
no  complex  schemes  for  withdrawing  them.  Let  them 
be  funded  in  low-interest-bearing  bonds. ^ 

§  7.  The  movement  urging  on  the  Baltimore  Plan 
was  soon  merged  in  the  general  activity  of  business  men 
which  led  to  the  Indianapolis  Convention  of  January  12, 
1897,  and  the  appointment  of  the  Monetary  Commission 
of  the  same  year.  The  outcome  of  that  commission  ap- 
peared directly  in  the  act  of  March  14,  1900,  chiefly  con- 
cerned with  the  maintenance  of  the  gold  standard  (as  ex- 
plained already  in  Chapter  I).  But  its  recommendations 
for  the  gradual  withdrawal  of  the  greenbacks,  in  connec- 
tion with  a  revision  of  the  issues  by  the  banks,  were  not 
carried  out.  Although  this  act  chronologically  came  after 
the  proposals  of  the  Baltimore  Plan,  it  comes  first  in  the 
evolution  of  thinking  on  money  and  banking  and,  there- 
fore, is  first  disposed  of  in  this  volume. 

The  work  of  this  commission,  however,  was  directly 
concerned  with  a  study  of  our  banking  system,  the  in- 
elasticity of  its  issues,  and  it  advocated  at  length  in  its 
final  report  (1898)  measures  aiming  to  substitute  com- 

1  The  main  arguments  presented  against  the  Baltimore  Plan  were  that  it 
gave  to  the  banks  the  power  and  right  to  create  money;  that  this  power  be- 
longed solely  to  the  government,  and  that  the  banks  would  thereby  be  allowed 
to  make  money  scarce  or  plentiful  to  their  own  gain.  On  this  general  argu- 
ment see  Laughlin,  Money  and  Prices,  chap.  X,  "Government  vs.  Bank 
Issues." 


ELASTICITY  OF  BANK-ISSUES  37 

mercial  paper  for  government  bonds  as  security  for 
bank-notes.  The  material  presented  in  that  report  was 
widely  studied  and  had  no  little  influence  on  the  think- 
ing of  that  time.  Its  proposals  were  at  first  more  or 
less  unfamiliar  to  the  public,  and  even  to  the  rank  and 
file  of  the  banking  profession,  and  yet  in  ten  years  its 
recommendations  were  practically  all  incorporated  in  the 
bill  of  the  American  Bankers'  Association  in  1908  and 
presented  to  Congress  in  that  year. 


108657 


CHAPTER  ni 

INFLUENCE  OF  THE  PANIC  OF  1907 

§  1.  The  intention  in  this  chapter  is  not  to  give  a 
general  history  of  the  panic  of  1907,  but  only  to  show 
how  the  panic  affected  the  evolution  of  thinking  on  bank- 
ing and  how  the  groping  through  the  matters  affecting 
notes  and  media  of  exchange  led  to  the  underlying  prob- 
lems of  the  organization  of  credit. 

The  inelasticity  of  our  forms  of  money  had  by  this 
time  become  a  trite  subject;  but  the  conditions  of  the 
money  market,  which  in  the  crisis  of  1907  led  to  a  general 
resort  to  clearing-house  certificates  throughout  the  coun- 
try, brought  a  new  interest  in  measures  of  reform.  Ob- 
viously, a  strong  impetus  was  given  to  the  discussion  of 
an  emergency  issue  by  the  national  banks,  and  there 
was  an  evident  determination  to  secure  currency  legisla- 
tion from  the  next  session  of  Congress. 

As  every  one  knew,  our  greenbacks  (United  States 
notes)  and  our  silver  circulation  were  fixed  at  a  rigid 
limit,  which  could  be  neither  increased  nor  diminished. 
The  national  bank  notes  were,  also,  inelastic,  for  all 
practical  purposes.  Therefore,  of  all  our  varied  forms 
of  lawful  money,  only  gold  was  truly  elastic.  If  we  had 
too  much  we  could  send  it  to  the  arts,  or  ship  it  abroad; 
if  we  had  too  little,  we  could  import  from  any  market 
in  the  world  on  wliich  we  had  credits.  Finally,  as  had 
been  displayed  during  the  panic  in  an  impressive  manner, 
the  only  "currency"  which  is  really  elastic  in  every 
sense,  and  the  only  one  to  be  resorted  to  when  every  other 
medium  of  exchange  is  unavailable,  is  the  deposit-cur- 

38 


INFLUENCE  OF  THE  PANIC  OF  1907      39 

rency  (checks  drawn  on  deposits).  While  clearing-house 
certificates  are  in  use  only  between  banks,  checks  have 
become  the  general  and  efficient  currency  with  which 
merchants  meet  their  engagements  both  with  individuals 
and  the  banks.  If  a  borrower  can  get  a  loan,  he  can  meet 
his  maturing  obligations  effectively  by  the  use  of  checks. 
In  a  crisis,  therefore,  the  one  important  thing  is  getting 
the  loan,  and  getting  it  in  the  form  of  a  means  of  pay- 
ment which  his  creditor  will  accept. 

Yet,  borrowers  may  in  some  cases  require  notes  which 
can  be  used  in  paying  wages,  and  in  meeting  the  needs 
of  retail  trade,  expenses  of  travel,  and  the  like.  In  a 
crisis  like  that  of  1907  this  kind  of  a  demand  for  money 
might  have  been  adequately  met  by  the  issue  of  bank- 
notes; and  the  amount  of  la^'ful  money  in  the  pockets 
of  the  people  might  have  been  replaced  safely  by  such 
notes.  When  frightened  depositors  drew  and  hoarded 
money,  it  was  usually  taken  from  lawful  money  reserves, 
alid  reduced  the  immediate  power  of  the  bank  to  lend 
under  certain  conditions  by  at  least  four  times  the  sum 
of  the  withdrawals.  Therefore,  if  those  depositors  could 
have  been  induced  to  accept  bank-notes,  instead  of  law- 
ful money  (gold  and  gold  certificates,  silver  and  silver 
certificates,  greenbacks,  and  treasury  notes  of  1890), 
there  would  have  been  at  hand  a  means  of  quieting  the 
public  alarm,  and  of  preventing  what  was  practically  a 
general  suspension  of  cash  payments.  To  this  extent  the 
issue  of  an  emergency  circulation  by  the  national  banks 
would  have  had  a  salutary  influence.  There  was  here  a 
field  for  bank-notes  of  unmistakable  importance,  which 
justified  all  the  arguments  in  favor  of  new  legislation, 
such  as  was  proposed  by  the  Fowler  Bill,  or  by  that  of 
the  American  Bankers'  Association. 

A  period  of  panic  invariably  enforced  the  necessity  of 


40  BANKING  PROGRESS 

some  marginal  elasticity  on  the  total  circulation.  In- 
ability to  obtain  circulating  notes  for  cash  payments 
necessarily  intensified  the  unfortunate  conditions  inci- 
dent to  a  collapse  of  credit.  In  the  summer  of  1893  it 
was  practically  impossible  to  obtain  a  sufficient  supply 
of  a  circulating  medium  of  any  kind.  On  June  1,  1893, 
the  banks  of  New  York  held  $21,000,000  in  excess  of 
their  legal  cash  reserves.  The  national  bank  notes  then 
outstanding  were  about  $177,000,000.  The  exceptional 
demands  for  currency  had  drawn  down  the  reserves  of 
the  New  York  banks,  by  August  1,  $14,000,000  below 
the  legal  minimum.  Yet  the  total  of  the  national  bank 
notes  outstanding  at  that  date  had  risen  by  only  $5,000,- 
000.  By  September  1,  when  the  emergency  had  passed 
and  currency  was  once  more  relatively  abundant,  the 
national  bank  notes  had  expanded  to  $199,800,000,  and 
later  rose  by  November  1  to  $209,300,000. 

The  experience  in  the  panic  of  1907  was  confirmatory. 
Then,  the  height  of  the  crisis  came  in  October.  Every 
possible  effort  was  made  to  increase  the  bank-note  cir- 
culation, but  to  little  effect.  So  scarce  was  currency 
that  the  clearing-houses  in  some  cities  issued  certifi- 
cates of  small  denominations  to  circulate  as  money  in 
the  hands  of  the  public.  On  July  1  the  circulation  of 
the  national  banks  was  $603,788,690,  but  by  October  31 
it  was  only  $609,980,466;  while  during  November  it 
had  risen  to  $656,218,196,  and  by  December  31  to  $690,- 
130,894.  The  bulk  of  this  increase  came  too  late  to  re- 
lieve the  currency  stringency.  Furthermore,  in  the  fol- 
lowing months,  when  the  clearings  showed  a  decrease  of 
over  28  per  cent,  and  when  the  circulation  should  have 
declined  correspondingly,  the  national  bank  notes  actu- 
ally increased  by  about  $8,000,000.  There  was  no  elas- 
ticity by  contraction  when  the  need  had  passed  by. 


INFLUENCE  OF  THE  PANIC  OF  1907      41 

It  resulted,  also,  from  the  panic  of  1907  tliat  a  more 
liberal  policy  was  introduced  by  the  Treasury  in  regard 
to  the  deposit  of  bonds  as  security  for  public  funds.  It 
was  found  that  nearly  all  the  available  government 
bonds  had  been  deposited  with  the  Treasury  either  to 
secure  national  bank  notes,  or  deposits  of  public  funds. 
This  led  to  a  release  by  the  Treasury  of  government 
bonds  behind  public  deposits  with  the  banks,  in  order 
that  more  bonds  could  be  used  to  secure  bank-notes. 
Previously  the  Treasury  had  begun  to  accept  other  than 
government  bonds  as  security  for  deposits.^  Thus  the 
public  mind  was  gradually  being  prepared  to  think  of 
other  than  government  bonds  as  a  safe  security  even 
for  national  bank  notes. 

§  2.  The  public,  however,  seemed  to  be  looking  for 
more  than  this  from  coming  legislation;  to  ask  for  an 
elastic  currency,  seasonal  elasticity  for  crop  movements, 
was  not  the  only  thing  needed.  It  was  hoped  that 
a  new  currency  law  would  give  the  means  of  averting 
the  diflSculties  of  a  commercial  crisis;  but  it  is  well  to 
make  clear  that  such  a  hope,  if  based  solely  on  note- 
issues,  was  wholly  elusive.  There  was  more  than  one 
element  in  the  situation  which  was  then  beyond  the 
influence  of  legislation,  present  or  future.  In  the  first 
place,  there  was  general  agreement  that  the  high  rates 
of  interest  of  that  time,  not  only  in  the  United  States 
but  in  Europe,  were  due  to  a  relative  scarcity  of  capital. 
The  prodigious  development  of  our  resources,  and  the 
expansion  of  opportunities  for  the  use  of  capital  here, 
had  accompanied  a  more  or  less  corresponding  growth  in 

*In  the  act  of  March  4,  1907,  sec.  3,  it  was  said:  "The  Secretary  of  the 
Treasury  shall  require  the  associations  thus  designated  [as  depositaries]  to  give 
satisfactory  seciu-ity,  by  the  deposit  of  United  States  bonds  and  othervdse, 
for  the  safe-keeping,  etc." 


42  BANKING  PROGRESS 

Europe.  In  fact,  events  had  emphasized  the  truth, 
which  need  not  be  enforced  for  economic  students,  that 
interest  was  primarily  paid  for  capital,  not  for  "money.'* 
If  our  banks  had  had  abundant  capital  then,  they  would 
have  had  no  difficulty  whatever  because  of  any  lack  of  a 
medium  of  exchange  in  passing  it  over  to  railways,  or  to 
merchants,  who  wished  to  borrow.  An  entry  in  a  deposit- 
account  on  which  a  check  could  be  drawn  would  alone 
have  served  the  purpose.  In  truth,  there  was  no  "  scarcity 
of  money"  for  carrying  on  exchanges  other  than  those 
occasioned  by  the  demands  of  pay-rolls,  retail  trade,  and 
the  like.  The  great  need  was  for  a  loan;  and  the  only 
real  scarcity,  so  far  as  it  concerned  money,  could  have 
been  only  in  the  kind  which  was  available  for  lawful  re- 
serves, and  which  affected  the  immediate  ability  of  a 
bank  to  lend.  In  fact,  there  was  no  scarcity  of  gold 
in  the  world  with  which  reserves  could  be  increased; 
for  the  burden  of  recent  discussions  on  gold  has  been  an 
emphasis  on  the  vast  new  production  in  increasing  the 
level  of  prices.  In  short,  the  scarcity  of  lawful  reserves 
in  the  banks,  or  the  consequent  limitation  of  loans,  could 
have  been  directly  traceable  only  to  a  lack  of  banking 
resources  with  which  to  buy  enough  gold  to  carry  the 
growing  burdens  of  trade,  or  to  the  fact  that  the  invest- 
ments of  the  bank's  resoiu'ces  were  in  assets  of  a  more  or 
less  speculative  quality  which  could  not  be  realized  upon 
in  an  emergency.  Therefore,  to  the  extent  that  pro- 
motion schemes,  or  overtrading,  formed  the  basis  of 
bank  loans  we  had  a  case  of  abnormal  credit  to  deal  with. 
The  acceptance  of  questionable  collateral  is  wholly  a 
matter  of  banking  judgment  and  it  has  nothing  what- 
ever to  do  with  abimdance  or  scarcity  of  money.  Even 
if  reserves  were  full,  a  bad  loan  would  still  remain  a  bad 


INFLUENCE  OF  THE  PANIC  OF   1907      45 

loan.  It  is  to  be  seen,  then,  that  congressional  legisla- 
tion could  not  be  expected  to  remedy  any  lack  of  capital, 
or  to  avert  the  effects  of  past  mis  judgment,  or  of  folly, 
in  accepting  doubtful  collateral. 

It  is  highly  important  to  disabuse  the  popular  mind 
of  the  fallacy  that  the  real  difficulties  of  a  crisis  like  that 
of  1907  could  be  removed  by  the  issue  of  bank-notes. 
As  has  been  repeatedly  said,  the  crucial  need,  the  one 
need  important  above  all  others,  was  that  of  obtaining 
a  loan  to  meet  maturing  obligations  or  of  continuing  a 
loan  already  made.  If  banks,  because  collateral  shrinks, 
or  loans  fall  due,  begin  to  call  in  loans,  and  refuse  con- 
tinuations, in  order  to  build  up  their  reserves,  general 
liquidation  and  depression  are  at  hand.  The  abihty  to 
lend  is  the  crux  of  the  whole  matter;  and  other  things 
are  secondary  to  it.  How  true  this  is  may  be  seen  by 
the  action  of  the  Bank  of  England  in  a  panic.  While 
the  act  of  1844  has  not  saved  the  English  from  serious 
collapses  of  credit,  its  operation  has  disclosed  the  real 
source  of  trouble  in  the  ease  or  difficulty  of  getting  loans 
at  the  banking  department.  This  difficulty  did  not 
primarily  reside  in  a  lack  of  money;  nor  was  the  increase 
in  the  rate  of  discount  the  cause  of  a  direct  increase  in 
the  charge  for  gold  at  the  issue  department.  The  high 
rate  of  discount  affected  only  loans  at  the  banking  de- 
partment, which  is  entirely  independent  of  the  issue 
department.  When  new  loans  are  made  by  the  former, 
the  deposits  are  increased,  and  the  percentage  of  reserves 
to  deposits  is  lowered.  And  it  is  to  be  remembered  that 
Bank  of  England  notes  are  permitted  in  the  banking  re- 
serves. If,  in  a  crisis,  a  great  pressure  for  loans  devel- 
oped, the  bank — above  all  things — did  not  refuse  to  lend, 
even  if  its  reserves  were  drawn  down.     Instead,  the  di- 


44  BANKING  PROGRESS 

rectors  violated  the  law^  at  that  time  forbidding  the 
issue  of  more  than  about  sixteen  and  three-fourths  mil- 
lions of  pounds  on  the  security  of  government  bonds; 
took  bonds  from  the  assets  of  the  banking  department 
to  the  issue  department;  got  notes  on  the  security  of 
these  bonds;  and  thereby  replenished  the  lawful  re- 
serves of  the  banking  department.  This  meant  that 
all  borrowers  with  satisfactory  collateral  could  get  loans. 
That  fact  once  widely  knowTi  stopped  the  rush  for  loans 
not  absolutely  imperative;   and  the  alarm  subsided. 

The  lessons  from  the  previous  discussion,  as  well  as 
from  the  experiences  of  European  banks,  must  be  very 
plain.  Nothing  could  be  of  any  help  to  us  in  a  crisis 
which  did  not  aid  the  banks  in  lending  to  legitimate  bor- 
rowers. Only  in  so  far  as  assets  could  be  used  to  obtain 
more  lawful  money — money  which  could  be  added  to  the 
reserves,  and  thus  increase  the  power  of  the  banks  to  re- 
lieve needy  borrowers — could  mere  currency  schemes  be 
of  any  great  use  in  a  financial  crisis.  This  truth  could  be 
fully  appreciated  by  observing  at  that  time  the  purchase 
of  foreign  gold  by  use  of  credits  on  Europe  based  on  cot- 
ton or  grain  biUs,  or  on  the  sale  of  our  cheap  securities. 
Here  was  one  direct  way  of  securing  our  lending  power, 
and  of  supporting  our  commercial  houses  which  needed 
an  extension  of  loans;  since  changing  assets  into  gold 
directly  touched  their  immediate  power  to  lend.  The 
extraordinary  decline  of  lawful  reserves  in  the  New  York 
banks  for  the  week  ending  November  9,  1907,  to  $51,- 
000,000  below  the  legal  limit,  coupled  with  a  large  in- 
crease of  loans,  showed  that  the  banks  were  doing  the 

^  The  power  to  disregard  the  limit  fixed  by  the  act  of  1844  was  on  August 
6,  1914,  delegated  to  the  Treasury;  and  the  minimum  of  notes  secured  by 
bonds  has  risen  to  £18^^  millions.  For  the  working  of  this  system  in  the 
unequalled  panic  of  1914,  on  the  outbreak  of  the  European  War,  see  Laughlin, 
Credit  of  the  Nations,  chap.  III. 


INFLUENCE  OF  THE  PANIC  OF   1907      45 

only  wise  thing — making  necessary  loans — and  yet  liber- 
ally furnishing  actual  cash  to  other  parts  of  the  country 
out  of  their  reserves.  The  only  question  was  whether 
the  imports  of  foreign  gold  would  overtake  the  with- 
drawals from  the  reserves. 

The  only  other  direct  means,  under  the  law  of  that 
day,  was  to  collect  greenbacks,  silver,  and  treasury  notes 
of  1890.  The  last  had  been  almost  eliminated;  and  the 
former  two  were  rigidly  fixed  in  amount.  But,  we  heard 
on  every  side  of  a  demand  for  more  bank-notes.  Would 
the  issue  of  their  own  bank-notes,  their  demand-liabili- 
ties, increase  the  ability  of  the  banks  to  lend.'*  Evi- 
dently not.  These  notes  could  not  be  used  in  their  re- 
serves; nor  should  they  ever  be  so  allowed.  In  short, 
apart  from  protecting  reserves  from  a  drain,  an  elastic 
bank  currency  could  not  directly  avert  the  essential  diffi- 
culties of  the  situation.  The  supposed  elasticity  in  a 
financial  crisis  was  not,  as  is  usually  thought,  a  matter 
merely  of  more  "money." 

§  3.  In  this  connection,  the  plan  of  the  American 
Bankers'  Association^  and  that  of  the  Fowler  Bill  should 
not  be  overlooked.  These  plans  were  on  some  points 
practically  identical,  and  contained  the  following  pro- 
visions: 

1.  Any  national  bank  having  been  actively  doing  business 
for  one  year  and  having  a  surplus  fund  equal  to  20  per  cent  of 
its  capital  shall  have  authority  to  issue  credit  notes  as  follows, 
subject  to  the  rules  and  regulations  to  be  fixed  by  the  comp- 
troller of  the  currency: 

(a)  An  amount  equal  to  40  per  cent  of  its  bond-secured  cir- 
culation, subject  to  a  tax  of  2^^  per  cent  (3  per  cent  in  the  Fowler 
Bill)  per  annum  upon  the  average  amount  outstanding. 

*  See  infra,  Appendix  I. 


46  BANKING  PROGRESS 

(b)  A  further  amount  equal  to  123/2  P^r  cent  of  its  capital, 
subject  to  a  tax  at  the  rate  of  5  per  cent  per  annum  upon  the 
average  amount  outstanding  in  excess  of  the  amount  first 
mentioned. 

2.  The  same  reserves  shall  be  carried  against  credit  notes 
as  are  now  required  by  law  to  be  carried  against  deposits. 

3.  A  5  per  cent  guaranty  fund  for  the  redemption  of  the 
notes  of  a  defaulting  bank. 

4.  Numerous  redemption  offices  in  various  parts  of  the 
country,  to  secure  easy  and  quick  redemption  when  desired. 

5.  The  repeal  or  the  modification  of  the  act  of  July  12,  1882, 
limiting  the  withdrawal  of  notes  to  $3,000,000  in  any  one  month. 

It  will  be  observed  from  these  pro\'isions  (1)  that  the 
emergency  circulation,  in  the  issue  of  at  least  the  first 
40  per  cent,  was  contingent  upon  the  bank's  previous 
issue  of  notes  secured  by  government  bonds.  When  we 
remember  that  the  largest  city  banks  had,  as  a  rule, 
made  little  or  no  use  of  their  right  to  issue  notes,  and 
that  they  had  done  their  enormous  business,  earned 
their  profits,  and  built  up  their  huge  surpluses,  solely 
by  the  use  of  the  deposit-currency,  we  shall  see  that 
were  such  legislation  obtained  the  great  banks  of  New 
York  and  other  cities  would  not  have  been  able  in  such  a 
crisis  as  that  of  1907  to  issue  any  emergency  notes  to 
speak  of. 

Again,  it  is  to  be  noted  (2)  that  the  same  reserves  of 
lawful  money  were  to  be  maintained  behind  these  emer- 
gency notes  as  behind  ordinary  demand-deposits.  If 
this  were  enacted,  and  if  there  were  a  great  pressure  for 
loans  from  the  business  public,  a  bank  would  be  just  as 
much  inhibited  from  granting  a  loan  in  the  form  of  its 
notes  as  in  the  form  of  its  deposits.  In  the  case  of  any 
drain  on  its  lawful  reserves,  it  would  be  checked  from 
lending  in  either  form.  The  privilege  to  issue  emer- 
gency notes  would  not,  under  such  a  law,  aid  the  banks 


INFLUENCE  OF  THE  PANIC  OF   1907      47 

in  lending  to  legitimate  borrowers,  and  therefore  in 
averting  the  disasters  due  to  weakened  confidence,  a  run 
on  cash  reserves,  or  eventual  liquidation.  In  short,  so- 
called  currency  evils  were  not  responsible  for  the  crisis; 
nor  would  the  legislation  here  proposed  have  met  the 
essential  needs  created  in  a  serious  financial  stringency. 
To  have  allowed  the  banks  to  increase  their  own  evi- 
dences of  debt  would  not  have  increased  their  reserves 
of  lawful  money,  or  their  ability  to  lend. 

§  4.  This  examination  of  the  proposed  reforms  of  our 
currency  ought  not,  however,  to  be  regarded  as  an  argu- 
ment against  the  desirability  of  other  and  more  advanced 
legislation.  The  reasons  for  wishing  an  elastic  bank 
currency  are  good  and  sufficient  in  themselves;  but  they 
must  not  be  used  for  supporting  emergency  notes  as  a 
real  cure  for  the  evils  of  such  a  financial  crisis  as  that  of 
1907.  In  justice  it  should  be  repeated,  on  the  other 
hand,  that  a  quick  issue  of  bank-notes  during  a  time  of 
threatened  danger  would  be  a  great  help  in  warding  off 
assaults  on  the  lawful  reserves.  Whenever  depositors 
call  for  "money,"  and  payments  are  made  in  the  bank's 
own  notes,  for  a  time  the  public  would  be  satisfied,  and 
the  lawful  money  reserves  would  be  kept  intact.  Thus, 
the  right  to  issue  emergency  notes  would  be  a  very  use- 
ful device  in  protecting  for  a  time  the  lawful  reserves 
from  depletion;  and  in  a  stringency  of  no  great  severity, 
the  amount  of  such  notes  would  prevent  the  evils  of  ab- 
normal credit  from  doing  much  injury. 

It  was  observed  by  Mr.  Fowler  that  an  enormous 
amount  of  lawful  money  was  out  in  the  hands  of  the 
people,  which,  if  in  the  reserves  of  the  banks,  would  be- 
yond all  question  increase  the  power  of  the  banks  to  lend. 
It  is  to  be  noted,  however,  that  increased  loans  should 


48  BANKING  PROGRESS 

go  with  an  increase  of  sound  assets  rather  than  with  a 
mere  enlargement  of  reserves.  Obviously,  the  banks 
ought — under  proper  safeguards — to  be  allowed  to  issue 
notes  in  such  denominations,  and  in  such  amounts  as  the 
public  want  them.  That  proposition  would  bring  in, 
however,  many  important  considerations,  one  of  which 
was  the  treatment  of  our  silver  circulation.  The  act  of 
1900  particularly  provided  means  by  which  the  large  sil- 
ver certificates  should  be  replaced  by  small  denomina- 
tions so  as  to  secure  their  being  kept  out  in  the  hands  of 
the  public.  Hence,  if  it  be  argued — and  there  was  a 
good  ground  for  the  argument — that  the  silver  circula- 
tion should  be  displaced  by  small  bank-notes,  then  the 
reform  of  our  currency  necessarily  included  the  various 
forms  of  silver  money.  This  made  it  clear  that  any- 
thing but  a  monetary  pis  aller  should  deal  with  more 
than  our  bank-note  issue.  Indeed,  sooner  or  later,  we 
had  to  face  the  larger  questions  in  our  currency  short- 
comings due  to  other  than  bank-issues.  That  1908  was 
not  the  psychological  hour  for  a  real  reform  was  later 
clearly  seen. 

If  we  were  capable,  in  this  country,  of  intelligently 
facing  the  problem  of  creating  an  efficient  method  of 
meeting,  or  mitigating,  the  inevitable  dangers  of  a  finan- 
cial crisis,  it  was  evident  as  early  as  1908  that  we  should 
establish  some  institution  wholly  free  from  politics,  or 
outside  influence — as  much  respected  for  character  and 
integrity  as  the  supreme  court — which  would  be  able, 
in  a  great  emergency,  to  use  government  bonds  or  selected 
assets  as  a  basis  for  the  issue  of  forms  of  lawful  money 
which  could  be  added  to  the  reserves  of  the  banks. 
Nothing  else  than  this  would  meet  the  imperative  need 
of  loans.  Bank-notes  are  not  a  legal  tender  between 
private  persons;   and  could  not  be  made  into  lawful  re- 


INFLUENCE  OF  THE  PANIC  OF  1907      49 

serves  for  the  very  issuers  of  the  notes.  It  is  doubtful 
if  a  great  central  bank — apart  from  its  political  impossi- 
bihty — would  accompHsh  the  desired  end.  It  is  con- 
ceivable, however,  that  a  commission  (or  board)  of  a 
high  order,  appointment  to  wliich  would  be  a  great  honor, 
might,  under  general  legislation,  be  competent  to  do  for 
the  United  States  what  in  effect  the  governor  and  direc- 
tors of  the  Bank  of  England  do  for  the  Enghsh  money 
market,  when  they  create  additions,  under  the  advice 
and  consent  of  the  government,  to  the  lawful  reserves  of 
the  banking  department.^ 

1  This  idea,  expressed  in  1907,  was  eventually  embodied  in  the  present  Federal 
Reserve  Board. 


CHAPTER  IV 

THE  ALDRICH-VREELAND  ACT 

§  1.  Although  the  Monetary  Commission  Bill  of 
1898^  was  advisedly  intended  to  be  a  transition  measure, 
retaining  as  a  compromise  a  partial  bond  feature,  the  re- 
port presenting  it  had  been  leavening  pubhc  opinion  for 
many  years.  That  presentation  brought  the  subject  be- 
fore bankers  and  legislators  for  practical  consideration. 
It  will  be  interesting  to  watch  how  far  it  has  colored  suc- 
ceeding legislation.  As  already  said,  the  bill  drawn  up 
by  the  Currency  Commission  of  the  American  Bankers' 
Association-  in  the  early  part  of  1908  contained  all  the 
important  provisions  of  the  earlier  bill.  Likewise,  the 
bills  introduced  at  this  time  by  Mr.  Fowler,  chairman  of 
the  House  Banking  Committee,  although  differing  from 
the  other  plans  in  simplicity  and  in  the  means  for  carry- 
ing out  the  change  from  the  old  to  the  new  system,  were 
founded  on  the  same  general  principles.  Finally,  the 
panic  of  1907,  as  already  explained  in  the  preceding 
chapter,  pricked  public  feeling  into  a  demand  for  addi- 
tional legislation  on  banking;  and  the  politicians  became 
jBrmly  convinced,  especially  in  view  of  the  coming  presi- 
dential campaign  of  1908,  that  this  public  opinion  must 
be  satisfied  by  some  kind  of  legislation.  The  conse- 
quence was  the  Aldrich-Vreeland  Act  (H.  R.  21871)  of 
May  30,  1908.  It  is  a  curious  compound  of  conflicting 
views,  compromise,  haste,  and  politics;    but  it  became 

'  See  Report  of  the  Monetary  Commission  (1898),  pp.  60-74. 
'  See  Appendix  I. 

50 


THE  ALDRICH-VREELAND  ACT  51 

the  law  of  the  land,  and  its  provisions  ought  to  be  sub- 
mitted to  careful  scrutiny. 

The  pohtical  considerations  affecting  the  passage  of 
the  act  are  not  all  clearly  explicable.  The  Repubhcans 
had  played  fast  and  loose  with  the  money  question  in 
the  past;  and  the  Democrats  had  lost  prestige,  and  two 
campaigns,  by  taking  up  silver.  Neither  party  had  been 
consistent.  In  early  days,  the  Democratic  party — as  in 
the  time  of  Benton  and  Jackson — advocated  the  gold 
standard  and  opposed  a  great  central  bank;  but  it  forced 
the  extinction  of  the  Second  United  States  Bank  largely 
because  it  had  tried  to  exact  redemption  for  the  State  bank 
issues  in  the  South  and  West.  At  the  close  of  the  Civil 
War  the  Democrats  took  up  with  the  greenback  craze, 
thus  allowing  their  opponents  to  appeal  to  the  business 
public  as  the  champions  of  sound  money.  The  Repub- 
licans passed  the  act  of  1869  strengthening  the  public 
credit,  passed  the  Resumption  Act  of  1875,  and  resumed 
specie  payments,  January  1,  1879.  The  victory  over 
greenbackism  and  inflation  was  not  an  easy  one;  and 
when  the  Democrats  introduced  the  silver  mania  as  a 
substitute  for  greenbackism  the  Republicans  wavered. 
The  protectionists  bought  their  legislation  by  votes  for 
silver;  and  Republicans  helped  to  pass  the  Bland- 
Allison  Act  of  1878.  Moreover,  they  were  chiefly  re- 
sponsible for  the  Sherman  Act  of  1890,  which  was  fol- 
lowed by  a  panic  and  the  repeal  of  silver  purchases  in 
1893. 

It  was  this  departure  of  the  Republican  party  from 
sound  monetary  policy — on  the  ground  of  expediency  in 
catching  votes — which  gave  the  opportunity  to  the 
Democrats  under  the  leadership  of  President  Cleveland 
to  outgeneral  their  opponents.  By  a  stroke  of  political 
genius  Cleveland  manoeuvred  the  Democrats  into  the 


52  BANKING  PROGRESS 

position  of  advantage  formerly  occupied  by  the  Repub- 
licans, and  restored  to  them  their  ancient  advocacy  of 
the  gold  standard.  Then,  for  the  first  and  only  time  since 
the  Civil  War,  did  the  Democrats  elect  their  candidate 
for  President.  Immediately  thereafter  a  populistic  wave 
overwhelmed  the  Democrats  and  carried  them  off  under 
Bryan  to  the  desert  of  silver  and  bank  hostility.  Their 
opposition  to  the  gold  standard,  and  their  ignorant  atti- 
tude on  banking  legislation,  lost  them  the  confidence  of 
the  electorate. 

The  Republicans,  however,  went  right  only  by  acci- 
dent and  expediency.  The  errors  of  their  opponents 
showed  them  the  pitfalls  to  avoid;  but  it  was  not  an 
understanding  of  the  monetary  question  nor  a  patriotic 
desire  to  give  the  business  and  industrial  interests  of  our 
land  a  banking  sj^stem  best  adapted  to  further  domestic 
and  international  trade  which  actuated  the  policy  of 
the  Republicans.  They  had  been  on  the  fence;  and  they 
finally  got  down  on  the  gold  side  only  because  they  saw 
the  Democrats  struggling  in  the  brambles  on  the  silver 
side.  They  deliberately  used  the  money  question  as  a 
means  of  retaining  political  power  and  for  years  kept  the 
business  interests  of  the  country  on  tenter-hooks  for  the 
sake  of  party  advantage.  It  was  not  the  favor  of  the 
business  public,  but  the  popuhsm  and  wildness  of  the 
Democrats  on  money,  which  kept  the  Repubhcans  in 
power.  In  1900  the  latter  were  unwdlhng  fully  to  estab- 
lish the  gold  standard  in  the  act  of  March  14,  1900,  by 
makmg  our  silver  coins  redeemable  in  gold,  because  they 
believed  there  was  still  a  chance  of  preventing  the  dis- 
cussion of  the  tariff,  and  retaining  public  support,  by 
keeping  the  money  issue  open.  This  is  an  illustration 
of  the  price  that  industry  pays  to  politics  in  a  democracy. 

Then,  when  the  panic  of  1907  forced  the  temporary 


THE  ALDRICH-VREELAND  ACT  53 

suspension  of  payments  by  banks  from  the  Atlantic  to 
the  Pacific,  and  brought  on  an  issue  of  clearing-house 
certificates  and  clearing-house  currency  in  default  of 
ordinary  forms  of  money,  the  party  in  power  felt  that 
the  unthinking  voters  would  charge  it  with  the  respon- 
sibility for  not  having  legislated  in  favor  of  an  abundant 
circulation.  The  theory  on  which  the  supposed  demand 
for  legislation  was  based  was  that  the  panic  was  due  to  a 
scarcity  of  money.  Of  course,  this  specious  reasoning 
was  nothing  more  or  less  than  the  old  argument  of  the 
greenbackers  and  the  silverites.  Yet  with  the  politi- 
cians the  point  was  not  whether  the  theory  was  right  or 
wrong;  it  was  whether  or  not  the  theory  was  actually 
held  by  masses  of  voters  who  were  to  be  cajoled. 

In  connection  with  the  measures  taken  by  the  Treasury 
to  meet  the  effects  of  the  panic  we  heard  from  President 
Roosevelt  and  the  politicians  an  emphasis  upon  the  sup- 
posed aid  which  could  be  rendered  by  the  issue  of  enor- 
mous sums  of  currency.  Even  the  sale  of  Panama  bonds 
and  3  per  cent  certificates  was  heralded  by  triumphant 
words  of  inflation  as  an  addition  to  the  currency.  It 
matters  little  that  these  securities  were  not  money;  it 
was  hoped  to  hoodwink  the  people.  There  seemed  to  be, 
in  the  matter  sent  out  from  Washington  to  the  press, 
little  understanding  of  the  causes  of  the  panic;  in  fact, 
the  performances  of  the  Treasury  were  the  crudest  in  our 
monetary  history — and  that  is  saying  a  good  deal.  Hav- 
ing no  policy  as  to  monetary  reform  beyond  that  of 
political  expediency,  it  was  not  to  be  expected  that  the 
Republicans  would  treat  banking  legislation  on  its  merits. 
Here  is  the  milk  in  the  cocoanut.  No  legislation  is  to 
be  had  solely  because  an  understanding  of  banking  prin- 
ciples directs  a  specific  reform;  the  political  leaders  in 
power  do  not  have  sufficient  courage  to  do  what  is  really 


54  BANKING  PROGRESS 

needed  by  the  commercial  public,  provided  enough  whit- 
tlers  on  store-boxes  at  the  country  crossroads  have  other 
views  as  to  what  should  be  done. 

The  Democrats,  as  usual,  took  the  populistic  attitude 
in  urging  the  issue  of  all  notes  by  the  government,  and 
tlie  withdrawal  from  the  banks  of  the  right  to  issue  notes. 
Thereby,  they  fortunately  gave  the  RepubHcans  a  politi- 
cal reason  for  favoring  some  legitimate  or  possible  basis 
for  the  issue  of  notes  by  the  banks.  The  question  was: 
What  basis  should  the  Republicans  adopt?  That  was 
the  crux  of  the  Aldrich-Vreeland  Bill. 

§  2.  In  the  session  of  Congress  following  the  panic  of 
1907  the  argument  for  new  legislation  contained  the  crude 
expectation  that  the  law  would  prevent  the  possibility 
of  future  panics.  This  view  was  expressed  both  in  a 
part  of  the  press  and  in  Congress,  and  showed  little  ap- 
preciation of  the  real  causes  at  work  in  an  inflation  of 
credit.  In  the  Senate,  where  the  members  of  the  Finance 
Committee,  under  the  leadership  of  Senator  Aldrich, 
were  also  the  practical  rulers  of  the  Republican  party, 
a  stern  opposition  was  early  expressed  against  any  form 
of  "asset-currency,"  and  this  policy  had  the  support 
of  the  President.  Evidently,  the  Republican  politicians 
believed  that  the  issue  of  notes  by  banks  on  other  secur- 
ity than  bonds  would  expose  their  party  to  attacks  in 
the  next  campaign  which  they,  in  their  general  incapacity 
on  banking  questions,  would  not  be  able  to  meet  success- 
fully. They  could  not  see  that  elasticity,  ready  expan- 
sion of  the  currency  in  time  of  need,  and  lower  rates  of 
interest  to  borrowers  might  be  popular  issues  with  the 
people  in  any  campaign. 

Also,  no  doubt,  there  was  a  conviction  in  the  minds  of 
many  senators  that  "asset-currency"  was  synonymous 


THE  ALDRICH-VREELAND  ACT  55 

with  "wildcat  currency"  and  involved  the  dangers  of 
uncontrollable  abuses  by  excessive  issues.  It  is  need- 
less to  say  that  those  dangers  do  not  inhere  in  any  legit- 
imate system  of  *' asset-currency,"  as  was  amply  proved 
by  its  use  in  the  chief  commercial  countries  of  Europe; 
but  it  is  interesting  to  note  that  leaders — ignorant  of 
banking  and  openly  flouting  the  advice  of  trained  bankers 
— ^produced  in  the  Senate  Aldrich  Bill  a  plan  for  notes 
issued  on  bonds  of  a  kind  as  like  those  of  "wildcat 
currency"  days  as  any  two  peas.  Looking  at  the  matter 
solely  as  politics,  it  is  difficult  to  understand  why  the 
Senate  stubbornly  thought  it  possible  to  gain  votes  by 
antagonizing  the  very  commercial  bodies  and  banking 
interests  who  were  most  competent  to  judge  of  such  mat- 
ters. It  is  a  matter  of  curious  interest  to  know  why 
there  was  political  capital  to  be  gained  from  urging  a 
bond-secured  system  of  note-issues  which  had  long  been 
known  to  have  been  outgrown,  rigid,  inelastic,  hurtful 
to  country  districts,  and  of  little  advantage  to  large  city 
banks  which  make  comparatively  small  use  of  the  issue- 
function.  The  bond-secured  system  lent  itself  to  such 
easy  and  popular  attacks  that,  as  a  political  move,  it 
proved  a  great  blunder.  When  the  Aldrich  Bill  came 
down  from  the  Senate  it  was  thoroughly  riddled  in  the 
House  by  the  representatives  of  industry  and  banking 
who  appeared  before  the  Banking  Committee;  and  in 
the  House,  which  much  more  nearly  represented  the  opin- 
ions of  the  public  than  the  Senate,  it  was  overwhelmingly 
defeated.  One  can  scarcely  avoid  the  conclusion  that 
the  Aldrich  Bill  represented  only  the  stolid  personal 
prejudices  of  a  very  few  mistaken  politicians  who  held 
the  reins  of  power. 

On  January  7,  1908,  Mr.  Aldrich  introduced  his  bill 
(S.  3023),  and  it  was  reported  out  by  the  Committee  on 


50  BANKING  PROGRESS 

Finance  with  amendments,  January  30,  1908.  Later,  be- 
fore passing  the  Senate,  some  radical  amendments  were 
added,  to  meet  the  views  of  such  men  as  Senator  LaFol- 
lette  (e.  g.,  sec.  11).  The  original  Aldrich  Bill  permitted 
a  national  bank,  having  an  outstanding  circulation  se- 
cured by  United  States  bonds  to  an  amount  not  less  than 
50  per  cent  of  its  capital,  and  which  had  a  surplus  of  20 
per  cent,  to  issue  additional  circulation  secured  by  bonds 
other  than  bonds  of  the  United  States.  These  other  bonds 
were  as  follows: 

Bonds  or  other  interest-bearing  obligations  of  any  State  of 
the  United  States,  or  any  legally  authorized  bonds  issued  by 
any  city,  town,  county,  or  other  legally  constituted  munici- 
pality or  district  in  the  United  States  which  has  been  in  ex- 
istence for  a  period  of  ten  years,  and  which  for  a  period  of 
ten  years  previous  to  such  deposit  has  not  defaulted  in  the  pay- 
ment of  any  part  of  either  principal  or  interest  of  any  funded 
debt  authorized  to  be  contracted  by  it,  and  whose  net  funded 
indebtedness  does  not  exceed  ten  per  centum  of  the  valuation 
of  its  taxable  property,  to  be  ascertained  by  the  last  preceding 
valuation  of  property  for  the  assessment  of  taxes;  or  the  first 
mortgage  bonds  of  any  railway  company,  which,  in  compliance 
with  existing  law,  reports  regularly  to  the  Interstate  Commerce 
Commission  a  statement  of  its  condition  and  earnings,  and 
which  has  paid  dividends  of  not  less  than  four  per  centum  per 
annum  regularly  and  continuously  on  its  entire  capital  stock 
for  a  period  of  not  less  than  five  years  previous  to  the  deposit 
of  bonds. 

Notes  secured  by  other  than  United  States  bonds  could 
be  issued  on  the  approval  of  the  secretary  of  the  treasury 
to  an  amount,  if  by  railway  bonds,  equal  to  75  per  cent, 
and  if  by  other  bonds,  to  90  per  cent  of  their  market 
value.  The  Umit  of  notes  issued  by  a  bank  was  the 
amount  of  its  capital  and  surplus;  and  the  total  of  this 
additional  circulation  issued  by  all  the  banks  was  to  be 


THE  ALDRICH-VREELAND  ACT  57 

$500,000,000.  To  allow  contraction,  United  States  bonds 
could  be  withdrawn  by  the  deposit  of  lawful  money; 
other  than  United  States  bonds,  by  the  deposit  of  lawful 
money  or  national  bank  notes.  The  notes  were  to  carry 
on  their  face  a  pledge  of  the  United  States  that  they  would 
be  redeemed  on  presentation  in  lawful  money.  A  tax 
of  3^  of  1  per  cent  was  levied  on  the  notes,  if  secured  by 
United  States  bonds  bearing  less  than  2  per  cent  interest; 
1  per  cent,  if  the  United  States  bonds  bore  more  than  2 
per  cent;  and  1  per  cent,  if  the  bonds  were  other  than 
United  States  bonds.  The  Aldrich  Bill  was  amended  so 
as  to  include  the  bonds  of  Porto  Rico  and  the  Philippine 
Islands,  but  to  exclude  American  railway  bonds.  It 
passed  the  Senate  (March  27)  and  was  referred  in  the 
House  to  the  Committee  on  Banking  and  Currency, 
March  30,  1908. 

As  opposed  to  this  Senate  measure  was  the  Fowler 
Bill,  reported  from  the  Banking  Committee  to  the  House. 
The  original  Fowler  Bill  (H.  R.  23017,  Fifty-ninth  Con- 
gress, Second  Session)  introduced  December  20,  1906, 
in  the  main  had  the  support  of  the  bankers.  This  bill 
followed  the  general  plan  of  the  Monetary  Commission 
of  1898,  but  proposed  a  gradual  change  from  notes  se- 
cured by  United  States  bonds  to  notes  secured  by  com- 
mercial assets.  According  to  it,  "National  Bank  Guar- 
anteed Credit  Notes,"  equal  to  40  per  cent  of  the  notes 
issued  by  a  bank  secured  by  United  States  bonds,  and  not 
exceeding  25  per  cent  of  its  capital,  could  be  issued  with- 
out the  deposit  of  any  United  States  or  other  bonds. 
Such  notes  to  pay  a  tax  of  3  per  cent.  An  additional 
amount  of  notes  equal  to  12}^  per  cent  of  the  capital 
could  be  issued  by  paying  a  tax  of  5  per  cent.  The  out- 
side limit  was  the  amount  of  the  capital.  The  holder  of 
these  credit  notes  was  to  be  a  general  creditor  of  the 


58  BANKING  PROGRESS 

issuing  bank.  A  guaranty  fund  of  5  per  cent  of  the  credit 
notes  was  established,  and  all  taxes  on  circulation  were 
to  be  covered  into  this  fund.  Additional  redemption 
cities  were  required. 

In  the  next  session  of  Congress  (Sixtieth  Congress, 
First  Session)  Mr.  Fowler  introduced  another  bill  (H.  R. 
12677),  January  8,  1908,  and  it  was  reported  out  by  the 
Committee  on  Banking  and  Currency,  February  29,  1908. 
In  this  later  bill  Mr.  Fowler  seemed  to  have  lost  the  sup- 
port of  the  American  Bankers'  Association;  and,  of 
course,  the  administration  and  the  leaders  in  Congress 
who  favored  a  bond-secured  circulation  opposed  it. 
His  measure  went  to  extremes,  and  included  many  other 
than  banking  schemes.  While  some  of  the  additions, 
excepting  the  guaranty  of  deposits,  were  meritorious. 
Congress  and  the  public  wished  to  act  on  only  one  thing 
at  a  time.  This  bill  (H.  R.  12677)  urged  the  creation  of 
not  more  than  twenty  bank  redemption  districts,  con- 
trolled by  eight  managers  and  a  deputy  comptroller,  and 
within  which  each  bank  should  select  a  redemption  centre 
for  its  notes.  Its  refusal  of  all  compromise  appeared  in 
its  allowing  a  bank  at  once  to  retire  all  its  notes  secured 
by  United  States  bonds  and  replace  them  with  notes, 
not  secured  by  bonds  of  any  kind,  to  a  hmit  equal  to  its 
capital ;  provided  the  bank  had  arranged  for  the  redemp- 
tion of  its  notes  in  gold  at  a  redemption  centre,  and  had 
deposited  with  the  Treasury  in  gold,  or  lawful  money,  5 
per  cent  of  its  notes,  and  5  per  cent  of  its  deposits,  as 
guaranty  funds.  If  the  district  managers  approved,  a 
bank  might  issue  an  additional  amount  of  notes  equal  to 
100  per  cent  of  its  capital.  Such  notes  would  have  a 
distinctive  color,  and  state  on  their  face  that  they  were 
redeemable  in  coin  and  guaranteed  by  a  fund  deposited 
with  the  Treasury.    After  January  1,  1909,  no  notes  se- 


THE  ALDRICH-VREELAND  ACT  59 

cured  by  bonds  were  to  be  paid  out.  Banks  were  to  pay 
2  per  cent  interest  on  government  deposits,  and  to  be 
freed  from  giving  bonds  as  security  for  deposits.  The 
notes  to  be  taxed  1  per  cent.  In  addition  the  measure 
contained  provisions  for  a  guaranty  of  deposits,  for 
enabling  national  banks  to  do  a  trust  business,  for  abol- 
ishing the  independent  treasury  system,  and  for  the  even- 
tual retirement  of  the  greenbacks. 

It  soon  became  evident  that,  while  the  House  would 
pass  a  bill  permitting  a  trial  of  commercial  assets  as  a 
basis  for  note-issues,  it  was  not  ready  to  throw  over  all 
bond  security;  and  also  that  the  House  would  not  pass 
the  Aldrich  Bill.  Hence,  both  the  Aldrich  and  the 
Fowler  Bills  were  impossible.  Yet  the  political  managers 
were  firm  in  the  belief  that  some  banking  bill  was  obliga- 
tory in  view  of  the  recent  panic.  A  caucus  of  the  Re- 
publican party  in  the  House  appointed  a  committee,  in- 
cluding Mr.  Vreeland  (New  York)  and  Mr.  Burton 
(Ohio)  but  excluding  Mr.  Fowler,  the  chairman  of  the 
Banking  Committee,  to  frame  the  bill.  Mr.  Fowler  had 
incurred  the  hostility  of  the  administration  and  of  the 
leaders  of  the  House  and  Senate,  and  was  officially  ig- 
nored. This  caucus  bill,  not  being  based  on  any  purpose 
to  touch  the  real  merits  of  the  problem,  was  wrung  from 
the  politicians  by  force  of  events. 

Two  bills  (H.  R.  21810  and  H.  R.  21871)  were  intro- 
duced by  Mr.  Vreeland  on  May  11  and  May  12,  1908. 
They  differed  only  in  slight  matters,  except  that  the  later 
bill  changed  the  words  to  be  printed  on  the  notes.  Re- 
demption by  the  United  States  was  dropped  out,  and  the 
words  of  the  act  as  finally  enacted  were  introduced. 
Knowing  this  measure  to  be  inspired  by  those  who  had 
the  power  to  enact  it,  its.  provisions  were  of  importance: 
National  clearing-house  associations,  made  up  of  not  less 


60  BANKING  PROGRESS 

than  ten  banks  having  an  aggregate  capital  and  surplus 
of  at  least  $5,000,000  were  created,  to  be  managed  by  a 
board  having  one  representative  from  each  bank  and 
given  the  power  to  issue  additional  notes  based  on  "any 
securities,  including  commercial  paper,  held  by  a  national 
banking  association,"  provided  the  given  bank  already 
had  outstanding  notes  secured  by  United  States  bonds 
to  an  amount  not  less  than  40  per  cent  of  its  capital. 
Notes  were  Hmited  to  75  per  cent  of  the  cash  value  of  the 
securities,  or  of  the  commercial  paper.  These  notes 
were  a  lien  on  all  the  assets  of  all  the  banks  in  the  given 
currency  association  issuing  the  notes.  The  limit  of  the 
issues  of  any  one  bank  was  its  capital  and  surplus;  and 
the  aggregate  of  the  additional  issues  (not  based  on 
United  States  bonds)  was  $500,000,000.  Banks  must 
hold  the  same  reserves  behind  the  emergency  circulation 
as  for  deposits;  notes  secured  by  2  per  cent  United  States 
bonds  to  pay  a  tax  of  3^  of  1  per  cent;  if  bearing  more 
than  2  per  cent,  a  tax  of  1  per  cent;  if  secured  through 
clearing-house  associations  {i.  e.,  on  commercial  paper, 
etc.),  a  tax  of  4  per  cent,  increasing  monthly  by  1  per 
cent,  until  10  per  cent  was  reached;  these  taxes  to  be 
covered  into  the  general  funds  of  the  Treasur5\  Notes 
secured  by  United  States  bonds  could  be  withdrawn  at 
a  rate  not  exceeding  $9,000,000  a  month;  if  otherwise 
secured,  no  such  limit  was  imposed.  The  directions  as 
to  the  wording  on  the  notes  were  as  follows: 

Such  notes  shall  state  upon  their  face  that  they  are  secured 
by  United  States  bonds  or  other  securities  according  to  law, 
shall  be  certified  by  the  written  or  engraved  signatures  of  the 
Treasurer  and  Register,  and  by  the  imprint  of  the  seal  of  the 
Treasury.  They  shall  also  express  upon  their  face  the  promise 
of  the  banking  association  receiving  the  same  to  pay  on  de- 
mand, etc. 


THE  ALDRICH-VREELAND  ACT  61 

Whenever  these  notes  were  presented  to  the  Treasury  for 
redemption,  they  should  be  redeemed  in  lawful  money. 
Finallj^  a  National  Currency  Commission  was  to  be  ap- 
pointed, having  six  senators,  six  representatives,  and  six 
others,  to  investigate  "the  causes  of  the  recent  financial 
crisis,"  and  to  make  recommendations  in  a  report  by 
January  1,  1909.  It  is  worth  noting  that  in  the  final 
enactment  the  commission  was  relieved  from  explaining 
the  causes  of  the  panic. 

Mr.  Fowler,  not  to  be  repressed,  introduced  his  bill 
again,  May  4,  1908,  shorn  of  its  extreme  provisions. 
Accepting  a  requirement  that  a  bank  should  already 
have  notes  outstanding  secured  by  United  States  bonds 
equal  to  50  per  cent  of  its  capital,  it  could  then  issue  50 
per  cent  more  not  secured  by  bonds;  and  in  an  emer- 
gency an  additional  sum  equal  to  100  per  cent  of  its  cap- 
ital and  surplus,  with  the  consent  of  district  managers 
and  the  comptroller.  On  January  1,  1909,  however,  all 
notes  secured  by  United  States  bonds  were  to  be  cancelled. 
The  provisions  for  guaranty  of  deposits,  trust  business, 
abolition  of  the  greenbacks  and  the  subtreasury  were 
dropped. 

This  bill,  favored  by  many,  was  rudely  set  aside  and 
the  Vreeland  Caucus  Bill  was  passed  in  the  House  by  a 
large  majority.  The  Senate  refused  to  accept  it,  the 
Aldrich  Bill  was  substituted,  and  the  matter  was  finally 
referred  to  a  conference  committee  of  both  Houses. 
After  considerable  struggle  in  conference,  in  which  much 
of  the  Aldrich  Bill  was  introduced  into  the  Vreeland  Bill, 
the  Aldrich-Vreeland  Bill  was  reported  to  both  Houses 
in  the  last  days  of  the  session,  and  hurriedly  passed  under 
the  party  lash,  May  30,  1908.  It  was  passed  before 
printed  copies  of  the  bill  were  distributed. 

Like  most  political  measures,  which  look  both  ways 


62  BANKING  PROGRESS 

and  try  to  conciliate  conflicting  interests,  the  Aldrich- 
Vreeland  Act  contained  many  inconsistencies.  On  the 
one  hand,  it  catered  to  a  supposed  pubHc  opinion  among 
the  masses  against  "asset-currency";  and  on  the  other 
hand,  it  aimed  to  win  the  eager  support  of  the  influential 
classes  owning  or  marketing  the  great  volume  of  financial 
securities.  By  inserting  much  of  the  Aldrich  Bill  into 
the  Vreeland  Bill  in  the  Conference  Committee,  the  bond 
interests  evidently  won  a  great  victory.  Nevertheless, 
in  view  of  the  evident  desire  to  play  politics  and  win  the 
most  votes,  it  is  almost  inconceivable  that  the  exceptional 
favors  to  holders  of  market  securities  should  have  been 
regarded  as  good  politics,  especially  as  the  measure  at 
the  same  time  alienated  large  banking  and  commercial 
interests. 

§  3.  This  Aldrich-Vreeland  Act,  emerging  from  such 
political  conditions,  was  entered  on  the  statute-books. 
It  is  therefore  important  as  a  part  of  our  banking  history 
to  know  just  what  its  provisions  were.  It  is  evident, 
from  the  start,  that  the  haste  with  which  it  was  pushed 
through  Congress  must  have  made  careful  legislation 
impossible.  In  some  quarters^  it  was  heralded  as  a  great 
triumph  of  Republican  monetary  policy;  and  in  other 
quarters  it  was  regarded  as  bad  in  theory,  and  a  cheat, 
because  it  was  offered  as  a  compromise  to  asset-currency 
advocates  in  a  form  greatly  minimizing  what  it  was  said 
to  offer.  Certainly  the  law  was  a  failure,  if  it  was  ex- 
pected to  quiet  the  urgent  demand  for  real  banking  re- 
form; and  the  political  gains  were  far  to  seek. 

One  evident  purpose  of  the  law  was  to  remove  in  the 
future  the  inability  of  the  banks  to  increase  their  note- 

^  Theodore  Gilman,  "The  Aldrich-Vreeland  Bill,"  North  American  Review, 
August.  1908. 


THE  ALDRICH-VREELAND  ACT  63 

issues  in  an  emergency  such  as  was  disclosed  in  the 
panic  of  1907.  And  it  must  be  admitted  that  in  a  mea- 
sure this  end  was  accomplished,  although  by  means  which 
proved  to  be  clumsy  and  not  foreseen  by  the  framers  of 
the  law.  The  act  enabled  a  bank  which  had  already 
outstanding  notes  secured  by  United  States  bonds  to  an 
amount  equal  to  40  per  cent  of  its  capital,  and  which 
had  a  surplus  of  20  per  cent,  to  take  out  additional  cir- 
culation either  (1)  on  certain  bonds  other  than  United 
States  bonds,  or  (2)  on  any  securities,  including  com- 
mercial paper;,  held  by  a  national  banking  association. 
In  (1)  the  bank  can  deal  directly  as  an  individual  with  the 
Treasury.  In  (2)  the  bank  must  act  through  a  national 
currency  association  created  by  this  law. 

The  preliminary  requirement  that  no  bank  could  issue 
additional  circulation  unless  it  had  already  outstanding 
notes  secured  by  United  States  bonds  equal  to  40  per 
cent  of  its  capital  was  one  that  created  serious  difficul- 
ties. It  was  a  part  of  the  persistent  adherence  to  a 
bond-secured  note-issue;  and  was  supposed  to  be  a  mea- 
sure of  a  transitional  character  on  the  way  to  some  new 
basis  of  security.  This  provision,  however,  seemed  to 
ignore  the  character  of  the  business  done  by  the  largest 
city  banks.  In  the  past  their  loan  and  deposit  functions 
had  been  chiefly  exercised  through  checks  on  deposits, 
and  actual  notes  had  been  little  called  for  in  large  transac- 
tions. Possibly  the  needs  of  country  correspondents 
may  have  increased  somewhat  an  otherwise  small  issue 
of  notes  by  banks  of  the  largest  size;  but  only  in  the 
panic  of  1907  had  these  large  banks  resorted  to  any  con- 
siderable issue  of  notes.  Therefore,  if  there  should  be  a 
general  desire  to  put  themselves  in  a  position  to  issue 
additional  notes  under  this  new  act,  the  banks,  under  the 
necessity  of  first  issuing  40  per  cent  of  bond-secured  notes. 


64  BANKING  PROGRESS 

would  certainly  greatly  increase  the  demand  for  United 
States  bonds.  July  31,  1908,  there  were  deposited  to  se- 
cure circulating  notes  United  States  bonds  to  the  amount 
of  $629,432,420;  and  to  secure  public  deposits,  $145,869,- 
372;  while  the  total  issue  of  bonds  outstanding  (including 
$14,086,500,  3  per  cent  certificates  of  indebtedness  issued 
November,  1907)  June  20,  1908,  was  $897,503,990. 
There  was  thus  very  little  leeway  for  increasing  notes  se- 
cured by  United  States  bonds,  in  view  of  the  considerable 
amounts  of  these  bonds  held  permanently  by  private  in- 
vestors. Now  it  was  for  the  very  reason  that  these  bonds 
were  high  and  scarce — how  scarce  could  well  be  appre- 
ciated by  those  who  tried  to  borrow  them  in  the  crisis 
of  1907 — that  the  banking  system  required  overhauling. 
And  yet  the  first  effect  of  the  act  was  to  send  up  the  price 
of  government  bonds,  already  perhaps  20  points  higher 
than  they  would  be  but  for  the  demand  for  them  as 
security  for  bank-notes.  It  was  a  serious  question  whether 
the  obstacle  of  a  large  previous  investment  in  United 
States  bonds  would  not  prevent  the  hoped-for  ease  of 
expansion  in  times  of  emergency.  It  would  certainly  be 
a  heavy  handicap;  and  it  was  one  more  illustration  of 
the  failure  of  the  act  to  meet  the  real  difficulties  of  the 
existing  banking  situation.  If  an  emergency  were  to 
arise,  the  banks  would  no  doubt  be  obliged  to  resort,  as 
before,  to  the  issue  of  clearing-house  certificates. 

§  4.  In  case  a  bank  had  satisfied  the  requirement  as 
regards  circulation  based  on  United  States  bonds,  then 
it  could  (1)  secure  additional  circulation  based  on  other 
than  United  States  bonds,  by  making  application  directly 
to  the  comptroller  of  the  currency,  and  without  the  in- 
tervention of  any  currency  association.  Notes  could  be 
issued  to  the  amount  of  90  per  cent  of  the  market  value 


THE  ALDRICH-VREELAND  ACT  65 

^    of  these  bonds,  and  were  limited,  all  told,  to  the  amount 
^   of  a  bank's  capital  and  surplus.     The  kind  of  bonds 
allowed  was  clearly  described  (sec.  3)  as  follows: 

Bonds  or  other  interest-bearing  obligations  of  any  state  of 
the  United  States,  or  any  legally  authorized  bonds  issued  by 
,  any  city,  town,  county,  or  other  legally  constituted  munici- 
1;  pality  or  district  in  the  United  States  which  has  been  in  exist- 
ence for  a  period  of  ten  years,  and  which  for  a  period  of  ten 
years  previous  to  such  deposit  has  not  defaulted  in  the  pay- 
ment of  any  part  of  either  principal  or  interest  of  any  funded 
debt  authorized  to  be  contracted  by  it,  and  whose  net  funded 
indebtedness  does  not  exceed  ten  per  centum  of  the  valuation 
of  its  taxable  property,  to  be  ascertained  by  the  last  preceding 
valuation  of  property  for  the  assessment  of  taxes. 

But,  (2)  should  a  bank  wish  to  make  use  of  its  commer- 
cial assets  as  a  basis  for  its  circulation,  it  must  act  through 
a  national  currency  association.  Such  a  voluntary  asso- 
ciation, modelled  somewhat  after  the  plan  of  a  clearing- 
house association,  must  contain  not  less  than  ten  banks, 
having  an  aggregate  capital  and  surplus  of  at  least  $5,- 
000,000.  To  it  was  given  legal  corporate  powers.  Only 
one  association  could  be  formed  in  any  one  city;  and  no 
bank  could  belong  to  more  than  one  association.  The 
banks  must  be  taken  from  contiguous  territory.  Any 
duly  qualified  bank,  on  application  to  the  secretary,  could 
force  its  entrance  into  an  association,  and  have  all  the 
rights  of  an  original  member.  Thus,  banks  in  New  Jersey 
or  Connecticut  could  insist  on  membership  in  the  asso- 
ciation of  New  York  City,  under  the  literal  interpreta- 
tion of  "contiguous  territory"  given  by  Secretary  Cor- 
telyou.  An  association  was  governed  by  a  board  con- 
sisting of  one  representative  from  each  bank.  Thus  a 
bank  with  a  capital  of  $25,000  had  equal  influence  with 
one  having  a  capital  of  $25,000,000,  and  it  was  discov- 


66  BANKING  PROGRESS 

ered  that  no  provision  existed  in  the  law  by  which  a  bank 
having  once  entered  could  ever  withdraw  from  an  asso- 
ciation. This  evidence  of  carelessness  in  drawing  up  the 
act  caused  great  hesitation  and  delay  in  the  formation  of 
associations.  In  October,  1908,  that  in  Washington, 
D.  C,  was  the  only  one  formed.^  Influential  banks,  held 
jointly  liable  with  small  banks  for  the  redemption  of 
any  notes  authorized  by  the  association,  were  slow  to 
enter  a  cornbination  from  which  they  could  not  withdraw 
in  case  of  bad  management.  Once  in,  a  bank  could  not, 
during  the  six  years  of  the  act,  withdraw  even  in  order 
to  take  out  notes  as  an  independent  bank  dealing  directly 
with  the  comptroller.  This  awkward  situation  was  cer- 
tain to  call  out  an  amendment. 

§  5.  Supposing  the  difficulties  connected  with  the 
forming  of  currency  associations  and  the  investment  in 
United  States  bonds  were  surmounted,  then  we  would  be 
face  to  face  with  the  new  methods  of  issuing  additional 
notes  based  on  banking  paper.  The  provisions  concerned 
with  the  basis  of  security  were  so  pivotal,  and  so  likely 
to  be  differently  interpreted,  that  it  is  well  to  quote 
them  herewith.  Indeed,  the  greatest  surprise  of  the  act 
is  probably  to  be  found  in  the  crudeness,  or  haste,  with 
which  the  law  was  framed  on  thesje  points: 

Sec.  1.  The  national  currency  association  herein  provided 
for  shall  have  and  exercise  any  and  all  powers  necessary  to  carry 
out  the  purposes  of  this  section,  namely,  to  render  available, 
under  the  direction  and  control  of  the  Secretary  of  the  Treasury, 
as  a  basis  for  additional  circulation  any  securities,  including 
commercial  paper,  field  by  a  national  banking  association.  For 
the  purpose  of  obtaining  such  additional  circulation,  any  bank 

^  Later,  on  the  urgent  request  of  Secretary  MacVeagh,  many  associations 
were  reluctantly  formed.     Cf.  Chapter  VIII,  §  1. 


THE  ALDRICH-VREELAND  ACT  67 

belonging  to  any  national  currency  association,  having  cir- 
culating notes  outstanding  secured  by  the  deposit  of  bonds 
of  the  United  States  to  an  amount  not  less  than  40  per  centum 
of  its  capital  stock,  and  which  has  its  capital  unimpaired  and 
a  surplus  of  not  less  than  20  per  centum,  may  deposit  with  and 
transfer  to  the  association,  in  trust  for  the  United  States,  for 
the  purpose  hereinafter  provided,  such  of  the  securities  above 
mentioned  as  may  be  satisfactory  to  the  board  of  the  association. 
The  officers  of  the  association  may  thereupon,  in  behalf  of  such 
bank,  make  application  to  the  Comptroller  of  the  Currency  for 
an  issue  of  additional  circulating  notes  to  an  amount  not  ex- 
ceeding 75  per  centum  of  the  cash  value  of  the  securities  or 
commercial  paper  so  deposited.  The  Comptroller  of  the  Cur- 
rency shall  immediately  transmit  such  application  to  the  Secre- 
tary of  the  Treasury  with  such  recommendation  as  he  thinks 
proper,  and  if,  in  the  judgment  of  the  Secretary  of  the  Treasury, 
business  conditions  in  the  locality  demand  additional  circula- 
tion, and  if  he  be  satisfied  with  the  character  and  value  of  the 
securities  proposed  and  that  a  lien  in  favor  of  the  United  States 
on  the  securities  so  deposited  and  on  the  assets  of  the  banks 
composing  the  association  will  be  amply  sufficient  for  the  pro- 
tection of  the  United  States,  he  may  direct  an  issue  of  addi- 
tional circulating  notes  to  the  association,  on  behalf  of  such 
bank,  to  an  amount  in  his  discretion,  not,  however,  exceeding 
75  per  centum  of  the  cash  value  of  the  securities  so  deposited: 
Provided,  That  upon  the  deposit  of  any  of  the  State,  city,  town, 
county,  or  other  municipal  bonds,  of  a  character  described  in 
section  three  of  this  Act,  circulating  notes  may  be  issued  to 
the  extent  of  not  exceeding  90  per  centum  of  the  market  value 
of  such  bonds  so  deposited;  And  provided  further.  That  no  na- 
tional banking  association  shall  be  authorized  in  any  event  to 
issue  circulating  notes  based  on  commercial  paper  in  excess  of 
SO  per  centum  of  its  unimpaired  capital  and  surplus.  The 
term  "conmiercial  paper"  shall  be  held  to  include  only  notes 
representing  actual  commercial  transactions,  which  when  accepted 
by  the  association  shall  bear  the  names  of  at  least  two  responsible 
parties  and  have  not  exceeding  four  months  to  run. 

In  these  words  we  have  the  final  outcome  of  the  whole 
struggle  between  those  in  favor  of  securing  notes  only  by 


68  BANKING  PROGRESS 

bonds  and  those  in  favor  of  securing  them  by  commer- 
cial assets.  If  United  States  bonds  were  no  longer  to  be 
the  sole  security,  then  the  system  of  a  bond-secured  cir- 
culation was  to  be  retained,  but  by  accepting  other  than 
United  States  bonds  as  a  basis.  This  was  the  policy  of 
the  Aldrich  Bill.  Senator  Aldrich  opposed  absolutely 
any  issue  of  notes  based  on  the  current  assets  of  banks, 
and  insisted  on  a  bond-secured  currency,  or  nothing. 
Only  when  the  House  leaders  were  unable  to  pass  the 
Aldrich  Bill  in  the  House,  as  already  explained;  when  it 
looked  as  if  the  party  must  go  before  the  country  con- 
fessing its  impotence  to  pass  any  kind  of  a  banking 
law;  and  only  when  some  recognition  of  commercial 
assets  as  security  became  essential  to  the  passage  of  a 
bill  through  the  House,  did  Senator  Aldrich  reluctantly 
yield.  Even  then  he  seemingly  intended  to  restrict  the 
use  of  bank  assets  within  the  lowest  possible  limits. 
Possibly  he  thought  he  had  allowed  only  "commercial 
paper,"  as  specifically  defined  in  the  act,  to  be  used  as 
security,  together  with  other  than  United  States  bonds. 
Then  it  was  that  Mr.  Vreeland  drew  up  his  bill,  with  an 
evident  understanding  with  the  Senate  leaders  on  this 
point.  In  fact,  the  wording  of  the  Vreeland  Bill  on  this 
matter  was  the  same  as  the  wording  of  the  act  which  was 
the  final  outcome  of  the  conference  between  the  two 
Houses. 

We  have  here,  however,  what  undoubtedly  proved  a 
surprise  to  the  banking  public,  who  naturally  supposed 
that  the  law  incorporated  the  purport  of  the  compromise. 
As  a  matter  of  fact,  the  supposed  intention  of  Senator 
Aldrich  was  not  expressed  in  the  law  as  passed,  whether 
from  conscious  intent,  or  ignorance  of  English,  or  of  the 
character  of  banking  paper,  it  is  hard  to  say.  But  it  is 
unlikely  that  so  astute  a  politician  did  not  fully  know 


THE  ALDRICH-VREELAND  ACT  69 

what  he  was  doing.  Moreover,  the  manner  of  making 
the  error  was  possibly  due  to  his  zeal  in  trying  to  include 
railway  bonds  in  the  general  class  of  those  other  than 
United  States  bonds.  It  will  be  remembered  that  the 
Aldrich  Bill  included  in  this  class 

the  first-mortgage  bonds  of  any  railroad  company,  which,  in 
compliance  with  existing  law,  reports  regularly  to  the  Inter- 
state Commerce  Association  a  statement  of  its  condition  and 
earnings,  and  which  has  paid  dividends  of  not  less  than  4  per 
centum  per  annum  regularly  and  continuously  on  its  entire 
capital  stock  for  a  period  of  not  less  than  five  years  previous 
to  the  deposit  of  the  bonds  (Section  2). 

Owing  to  the  political  clamor  against  the  railways,  Sen- 
ator Aldrich  had  to  see  this  provision  expunged  from  his 
bill.  But  when  the  bills  of  the  two  Houses  were  in  con- 
ference, it  was  possibly  not  noticed  that  the  original 
phraseology  of  the  Vreeland  Bill,  and  that  finally  enacted, 
allowed  "any  securities,  including  commercial  paper,  held 
by  a  banking  association"  to  be  used  as  security  under 
the  direction  of  the  secretary  of  the  treasury.  "Any 
securities"  included  not  only  first  mortgage  railway 
bonds,  but  any  of  the  $16,000,000,000  of  railway  securi- 
ties which  might  be  held  by  any  banking  association,  and 
accepted  by  the  secretary.  Nor  were  any  reports  to  the 
Interstate  Commerce  Commission  made  necessary,  nor 
the  payment  of  dividends,  as  mentioned  in  the  Aldrich 
Bill.  And  soon  the  secretary  was  confronted  with  the 
awful  responsibility  of  deciding  which  of  all  these  multi- 
farious railway  securities  he  ought  to  accept.  It  was  a 
condition  of  things  highly  satisfactory  to  politicians  and 
to  bond  dealers.  If  a  security  was  accepted  by  the  secre- 
tary every  national  bank  would  be  informed  that  it 
was  a  good  security  for  bank-notes.    Such  action  would 


70  BANKING  PROGRESS 

give  a  bond  or  stock  a  valuable  indorsement  and  greatly 
enhance  its  value.  It  opened  up  unlimited  possibilities 
for  pressure.  It  was  an  intolerable  and  an  unforeseen 
situation. 

But  the  inclusion  of  railway  securities  by  the  words 
**any  securities"  reaUy  introduced  the  greatest  surprise 
of  all  into  the  new  law.  Without  a  shadow  of  doubt  the 
language  used  was  so  broad  and  sweeping  that  it  allowed 
the  banks  to  offer  any  assets  held  by  them,  other  than 
"commercial  paper,"  as  specifically  defined  in  the  act, 
and  to  which  it  was  generally  supposed  the  banks  were 
limited.  The  verj^  pains  taken  to  define  "commercial 
paper"  would  lead  one  to  suppose  that  only  that  descrip- 
tion of  paper  would  be  accepted.  Such,  however,  was 
not  the  law.     The  act,  as  already  quoted,  runs  as  follows : 

The  national  currency  association  herein  pro\nded  for  shall 
have  and  exercise  any  and  all  powers  necessary  to  carry  out 
the  purposes  of  this  section,  namely,  to  render  available,  under 
the  direction  and  control  of  the  Secretary  of  the  Treasury,  as 
a  basis  for  additional  circulation  any  securities,  including  com- 
mercial paper,  held  by  a  national  banking  association. 

The  powers  here  granted  were  sweeping;  and  the  pur- 
pose of  granting  these  large  powers  was  defined  to  be: 
to  render  available  as  a  basis  for  additional  circulation 
any  securities  (including  one  specified  kind)  held  by  a 
national  bank.  The  words  "any  securities"  were  used 
as  a  general  or  generic  term,  covering  not  only  bonds, 
but  such  securities  as  commercial  paper.  Obviously,  as 
the  language  runs,  the  words  included  anything  other 
than  "commercial  paper'*  which  could  properly  be  in- 
cluded under  the  term  "any  securities."  The  interpre- 
tation hinges  upon  the  meaning  of  the  word  "securi- 
ties."   In  the  accounts  of  the  Bank  of  England  the  term 


THE  ALDRICH-VREELAND  ACT  71 

anployed  to  cover  all  loans  to  customers  is  "other  securi- 
ties." In  fact,  in  American  banking  usage,  the  word 
securities  is  commonly  applied  to  any  of  the  notes,  col- 
lateral, or  other  paper,  held  to  secure  the  repayment  of  a 
loan.     It  is  a  generic  term. 

The  word  "securities"  was  possibly  not  used  with  pre- 
cision in  the  act.  Clearly,  it  was  not  intended  to  be  made 
synonymous  only  with  bonds.  Probably  it  was  pur- 
posely left  ambiguous.  After  making  the  general  state- 
ment about  "any  securities,  including  commercial  paper," 
the  act  speaks  of  the  deposit,  in  trust  for  the  United  States, 
of  "such  of  the  securities  above  mentioned  as  may  be 
satisfactory  to  the  board  of  the  association."  Here 
securities  include,  of  course,  commercial  paper.  Again, 
in  sec.  1,  the  word  appears  generically  as  follows: 

If  he  [the  Secretary]  be  satisfied  with  the  character  and  value 
of  the  securities  proposed,  and  that  a  lien  in  favor  of  the  United 
States  on  the  securities  so  deposited  and  on  the  assets  of  the 
banks  composing  the  association  will  be  amply  sufficient  for 
the  protection  of  the  United  States,  etc. 

Here,  the  context  shows  that  the  word  "securities"  in- 
cludes the  discounted  bank  paper  on  which  notes  could 
be  issued  only  to  75  per  centum  of  "the  cash  value  of  the 
securities  so  deposited";  for  this  amount  of  75  per  cen- 
tum is  put  in  opposition  to  the  90  per  centum  of  notes 
to  be  issued,  if  the  basis  furnished  is  made  up  only  of 
bonds. 
Again  in  sec.  9,  in  regard  to  the  tax,  it  is  said: 

National  banking  associations  having  circulating  notes  se- 
cured otherwise  than  by  bonds  of  the  United  States  shall  pay 
for  the  first  month  a  tax  at  the  rate  of  5  per  centum  per  annum 
upon  the  average  amount  of  such  of  their  notes  in  circulation 
as  are  based  upon  the  deposit  of  such  securities,  and  afterwards 


72  BANKING  PROGRESS 

an  additional  tax  of  1  per  centum  per  annum  for  each  month 
until  a  tax  of  10  per  centum  per  annum  is  reached,  and  there- 
after such  tax  of  10  per  centum  per  annum,  upon  the  average 
amount  of  such  notes.  Every  national  banking  association 
having  outstanding  circulating  notes  secured  by  a  deposit  of 
other  securities  than  United  States  bonds  shall  make  monthly 
returns,  under  oath  of  its  president  or  cashier,  to  the  Treasurer 
of  the  United  States,  in  such  form  as  the  Treasurer  may  pre- 
scribe, of  the  average  monthly  amount  of  its  notes  so  secured 
in  circulation;  and  it  shall  be  the  duty  of  the  Comptroller  of  the 
Currency  to  cause  such  reports  of  notes  in  circulation  to  be 
verified  by  examination  of  the  banks'  records.  The  taxes  re- 
ceived on  circulating  notes  secured  otherwise  than  by  bonds 
of  the  United  States  shall  be  paid  into  the  Division  of  Redemp- 
tion of  the  Treasury  and  credited  and  added  to  the  reserve 
fund  held  for  the  redemption  of  United  States  and  other  notes. 

Obviously,  the  tax  is  the  same  on  notes  based  on  bonds 
other  than  United  States  bonds,  and  on  commercial 
paper.  If  so,  the  word  "securities"  was  used  generi- 
cally  to  include  both  kinds  of  protection  to  the  notes. 

The  act,  then,  permitted  the  issue  of  notes  on  (1) 
United  States  bonds,  (2)  on  approved  bonds  other  than 
United  States  bonds,  and  (3)  on  "any  securities,  including 
commercial  paper,  held  by  a  national  banking  associa- 
tion." It  distinctly  did  not  confine  the  issue  of  notes 
under  (3)  only  to  commercial  paper — although  it  defined 
commercial  paper  specifically;  and  although  it  provided, 
in  sec.  1: 

That  no  national  banking  association  shall  be  authorized  in 
any  event  to  issue  circulating  notes  based  on  commercial  paper 
in  excess  of  30  per  centum  of  its  unimpaired  capital  and  surplus. 

What  then  was  the  meaning  of  "any  securities,"  other 
than  "commercial  paper ".^^  Possibly  Congress  meant 
to  separate  the  class  of  bonds  distinctly  from  the  class  of 
"commercial  paper,"  and  to  use  securities  only  as  a 


THE  ALDRICH-VREELAND  ACT  73 

synonym  for  bonds.  Under  this  supposition,  notes  could 
be  based  only  on  (1)  United  States  bonds,  (2)  other  ap- 
proved bonds,  and  (3)  commercial  paper,  as  defined.  If, 
however,  this  was  the  intention,  it  was  certainly  not  so 
expressed  in  the  law.  For,  as  we  have  seen,  "securities" 
were  not  synonymous  with  bonds;  and  any  securities 
other  than  bonds  were  permitted,  including  "commercial 
paper." 

Why,  then,  was  commercial  paper  defined,  and  the 
issues  based  upon  them  limited  to  30  per  cent  of  the  cap- 
ital and  surplus?     The  definition  is  as  follows: 

The  term  "commercial  paper"  shall  be  held  to  include  only 
notes  representing  actual  commercial  transactions,  which  when 
accepted  by  the  association  shall  bear  the  names  of  at  least 
two  responsible  parties  and  have  not  exceeding  four  months 
to  run. 

Possibly,  it  was  the  intent  of  Congress  that  the  only 
bank  assets  on  which  notes  could  be  based  was  com- 
mercial paper;  but,  irrespective  of  this  definition  and  of 
the  30  per  cent  clause,  a  currency  association  was  given 
"any  and  all  powers  necessary  ...  to  render  available 
...  as  a  basis  for  additional  circulation  any  securities, 
including  commercial  paper,  held  by  a  national  banking 
association.^'  As  the  law  stood,  if  the  association  was 
limited  to  30  per  cent  of  its  capital  and  surplus,  when 
presenting  "commercial  paper,"  it  was  not  so  limited  if 
it  presented  other  bank  paper  not  classifiable  as  "commer- 
cial" under  the  definition.  In  truth,  those  assets  of  a 
bank  which  did  not  come  under  the  definition  of  "com- 
mercial paper"  were  given  more  liberal  treatment  than 
"commercial  paper,"  and  were  placed  outside  of  the 
operation  of  the  30  per  cent  clause. 
Undoubtedly,  some  members  of  Congress  must  have 


74  BANKING  PROGRESS 

thought  they  had  shut  off  the  issue  of  notes  on  all  assets 
(exclusive  of  government,  or  other  bonds),  except  com- 
mercial paper.  They  probably  wanted  to  distinguish 
between  "accommodation  paper,"  or  "finance  bills,"  on 
the  one  side,  and  legitimate  commercial  paper,  on  the 
other.  But  the  sweeping  general  clauses  of  the  act  did 
not  confine  the  securities  other  than  bonds  to  com- 
mercial paper,  as  defined  in  the  act.  The  wording  of  the 
law  left  the  gates  wide  open  for  the  deposit  of  any  securi- 
ties (i.  e,,  any  kind  of  paper)  held  by  a  national  bank, 
and  offered  by  a  currency  association,  subject  only  to 
"the  direction  and  control  of  the  Secretary  of  the  Trea- 
sury." At  least,  that  is  the  only  possible  interpretation 
which,  in  my  opinion,  would  be  given  by  the  courts.  And 
these  are  the  reasons  for  the  previous  statement  that  the 
law  provided  the  means  for  a  large  expansion  of  notes  in 
a  time  of  emergency — a  freedom  quite  unexpected  even 
by  advocates  of  "asset-ciu-rency."  Moreover,  the  House 
was  put  in  control  of  the  situation;  for,  if  an  attempt 
had  been  made  by  the  Senate  to  amend  its  mistakes,  the 
House,  in  which  there  was  a  majority  against  bond-secured 
circulation,  could  have  retained  the  law  as  it  stood. 
Any  repeal  or  amendment  required  the  consent  of  the 
House.  This  was  certainly  a  startling  outcome  of  the 
currency  struggle. 

The  new  law  introduced  some  difficulties  before  addi- 
tional notes  could  be  issued;  but  after  that  point  was 
reached,  the  gates  were  certainly  left  wide  open.  In 
case  of  another  panic  such  as  that  of  1907,  the  scramble 
for  currency  would  be  avoided,  the  reserves  more  or  less 
protected,  the  resort  to  clearing-house  checks  for  cur- 
rency in  daily  use  prevented,  and  a  sense  of  insecurity 
due  to  inability  to  get  currency  would  be  removed,  were 
this  Aldrich-Vreeland  Act — as  interpreted  above — then 


THE  ALDRICH-VREELAND  ACT  75 

in  force. ^  Of  course,  it  could  not  prevent  a  future  panic. 
No  act  could  do  that. 

In  addition,  the  notes  were  perfectly  safe.  The  banks 
must  keep  in  the  redemption  fund  (sec.  6)  a  sum  equal  to 
5  per  cent  of  its  additional  circulation  (other  than  that 
based  on  United  States  bonds),  as  distinct  from  the 
original  5  per  cent  redemption  fund  of  June  20,  1874. 
Thus  for  immediate  redemption  it  would  seem  that  for 
notes  secured  by  United  States  bonds,  only  5  per  cent 
was  required,  but  for  all  notes  otherwise  secured,  10  per 
cent.  The  Treasury  was  obliged  to  redeem  the  notes; 
but,  besides  the  securities  deposited,  the  Treasury  could 
have  recourse  to  all  the  assets  of  all  the  banks  in  a  cur- 
rency association.  The  taxes  paid,  moreover,  were  to 
be  turned  into  the  division  of  redemption  and  added 
to  the  reserve  fund  held  for  the  redemption  of  United 
States  and  other  notes,  thus  constituting  a  potential 
safety  fund  in  the  future. 

Also,  banks  had  to  pay  a  uniform  rate  of  interest 
throughout  the  country  of  at  least  1  per  cent  on  govern- 
ment deposits;  but  no  reserves  were  to  be  held  against 
such  deposits.  Nor  were  any  reserves  against  notes 
required. 

§  6.  The  Aldrich-Vreeland  Act  in  its  attempt  to  de- 
fine "commercial  paper,"  thus  opened  up  the  whole 
question  as  to  the  nature  and  classification  of  baiil<;ing 
assets.  The  contemptuous  rejection  by  the  leaders  of 
all  advice  from  bankers  undoubtedly  got  the  framers  of 
the  law  into  unsuspected  difficulties. 

If  only  "commercial  paper"  as  defined  in  the  act  were 
accepted,  then  there  would  have  been  excluded  all  loans 
based  on  legitimate  transactions  bearing  only  one  name. 

'  Cf.  the  experience  in  the  panic  of  1914.     Chapter  XI,  §  7. 


76  BANKING  PROGRESS 

Thus  the  one-name  notes  of  a  great  merchant,  or  the 
U.  S.  Steel  Corporation,  would  be  excluded.  The  sale 
of  goods  would  thus  be  no  basis  for  a  discount,  unless 
such  a  firm  went  out  and  obtained  an  additional  name. 
Such  a  discrimination  was  not  only  unfair,  but  it  ignored 
the  actual  trade  methods  used  in  this  country. 

Practically,  the  only  way  in  which  two-name  paper, 
based  on  actual  transactions,  is  presented  for  discount 
in  this  country,  is  that  in  which  so-called  "trade-paper" 
is  created.  When  a  merchant  buys  goods  in  the  United 
States  on  time,  he  receives  a  greater  or  less  discount  for 
paying  cash  before  the  account  is  due.  This  discount 
varies  in  different  trades.  In  groceries,  food  products, 
etc.,  the  sales  are  usually  on  10  days  time,  and  the  dis- 
counts play  no  real  part.  In  the  sale  of  luxuries,  such  as 
fine  millinery,  or  jewelry,  the  period  allowed  for  payment 
of  goods  may  be  6  months.  But  in  trades  like  hard- 
ware, the  time  runs  from  30  to  90  days.  Hence,  if  a 
discount  of  3  per  cent  is  allowed  by  the  seller,  provided 
cash  is  paid  in  10  days  on  goods  sold  at  90  days  credit, 
that  is  equivalent  to  3  per  cent  for  80  days,  or  at  a  rate 
of  133^  per  cent  per  annum.  Likewise,  a  discount  of  2 
per  cent  for  cash  paid  in  30  days  is  equal  to  12  per  cent 
per  annum.  Now,  if  the  buyer  has  good  standing  he 
can  borrow  at  4  or  5  per  cent,  and  pay  off  his  account, 
thereby  saving  the  difference  between  4  or  5  and  12  or 
133/^  per  cent.  The  longer  the  time  on  which  goods  are 
sold,  the  larger  the  discounts  and  the  greater  the  induce- 
ment to  borrow  and  to  anticipate  payment  of  the  account. 
Consequently,  the  merchants  having  the  best  credit 
never  wait  until  their  accounts  mature;  some  of  poorer 
credit  meet  payment  at  maturity;  and  others,  not  able 
to  pay  when  the  accounts  fall  due,  must  borrow  and  meet 
one  indebtedness  by  creating  a  new  one.    Now,  this  last 


THE  ALDRICH-VREELAND  ACT  77 

class,  the  poorest  of  all,  creates  two-name  paper,  based 
on  actual  transactions,  on  less  than  4  months  time 
usually,  which  would  be  technically  acceptable  as  "com- 
mercial paper"  security  for  note-issues;  while  the  paper 
of  the  men  of  higher  credit,  who  can  always  borrow  and 
save  on  the  trade  discounts,  would  not  be  acceptable. 
The  framers  of  the  act  were  lamentably  ignorant  of  Ameri- 
can trade  methods  and  the  nature  of  banking  paper.  In 
fact,  the  definition  of  "commercial  paper"  pivoted  mainly 
on  the  requirements  of  two  names.  But  it  is  obvious 
that  this  requirement  would  rule  out  some  of  the  best 
paper  held  by  banks. 

In  order  to  get  a  clear  idea  of  the  kind  of  assets  held 
by  national  banks,  having  chiefly  a  mercantile  clientele, 
the  following  classification  given  to  the  comptroller  by 
a  certain  well-managed  bank  will  give  us  the  average 
condition  of  such  institutions; 


A.  On  demand,  paper  with  one  or  more  individual  or  firm 

names $2,231,184.06 

B.  On  demand,  secured  by  stocks,  bonds,  and  other  per- 

sonal securities 4,063,083.61 

C.  On  time,  paper  with  two  or  more  individual  or  firm  names     8,350,629.34 

D.  On  time,  single-name  paper,  one  person  or  firm  without 

other  security 9,497,384.44 

E.  On  time,  secured  by  stocks,  bonds,  and  other  personal 

securities 5,604,183.75 

F.  Secured  by  real  estate,  mortgages,  or  other  lien  on  real 

estate 28,820.00 

$29,775,285.20 


Apparently,  according  to  the  definition  in  the  Aldrich- 
Vreeland  Act  of  the  paper  allowable  as  security  for  notes, 
through  currency  associations,  only  class  C  could  be  ac- 
cepted, and  only  that  part  which  could  be  strictly  con- 
strued as  based  on  actual  transactions.    Yet,  according 


78  BANKING  PROGRESS 

to  bankers,  this  is  not  as  a  rule  the  best  banking  paper 
held. 

As  every  one  knows,  also,  the  banks  deajing  mainly  in 
loans  of  a  mercantile  character  are  large  buyers  of  paper 
sold  by  note-brokers.  Such  notes  are  rarely  secured  by 
collateral,  and  usually  bear  one  name.  In  the  case  of 
large  corporations  the  indorsement  of  more  than  one 
officer  of  the  company  could  not  make  two-name  paper. 
J..1  b^jile  of  some  faults  in  such  loans — doubtless  remediable 
— ^the  extent  of  the  dependence  on  note-brokers  is  wide- 
spread. The  situation  is  well  expressed  by  a  prominent 
banker^  as  follows: 

The  ease  with  which  loans  are  obtainable  in  normal  times  by 
responsible  houses  on  their  own  direct,  unsecured  obligations, 
through  the  agency  of  note-brokers,  has  nearly  done  away 
with  trade-paper  [i.  e.,  two-name  commercial  paper]  of  the 
highest  grade.  All  good  concerns  and  many  even  in  second 
and  third  grade  credit  are  enabled  to  borrow  all  the  funds 
required  to  take  advantage  of  trade  discounts,  and  enough 
more  to  meet  aU  other  bills  at  maturity,  so  there  is  little  or  no 
reason  to  settle  trade  accounts  by  notes.  .  .  .  No  house  can 
habitually  do  so  without  ultimate  damage  to  its  credit.  The 
business  of  the  note-broker  in  directly  supplying  capital  when 
needed  by  solvent  borrowers  for  production  use  in  trade  is 
comparatively  a  modern  occupation,  and  it  is  highly  beneficial 
if  confined  within  legitimate  and  prudent  limits.  In  this 
country  the  business  has  developed  enormously  within  two  or 
three  decades  and  along  lines  that  were  unthought  of  a  few 
years  ago  and  which  then  would  have  been  deemed  impossible 
and  extremely  hazardous.  The  system  as  we  know  it  is  not 
in  common  practice  anywhere  else  in  the  world. 

All  such  paper  obviously  would  be  excluded  by  the  legal 
definition  of  "commercial  paper"  in  this  act. 

^  Joseph  T.  Talbert,  president  of  the  Chicago  Clearing-House,  "  Commercial 
Credits,"  an  address  before  the  New  York  State  Bankers'  Association,  July  10, 
1908. 


THE  ALDRICH-VREELAND  ACT  7^ 

The  loans  of  modern  banks  are,  of  course,  of  all  kinds; 
but  a  rough  division  may  be  made  as  follows:  (1)  loans 
to  customers  of  a  mercantile  character;  (2)  notes  pur- 
chased of  note-brokers,  and  (3)  loans  to  stock-brokers 
and  individuals.  The  last  class  (3)  are  usually  demand 
loans,  and  are  generally  fully  secured  and  usually  quite 
safe,  being  margined  on  quickly  salable  securities.  There- 
fore, if  only  "commercial  paper,"  as  defined,  were  ac- 
cepted as  security  for  notes,  classes  (2)  and  (3)  and  a  large 
part  of  (1)  would  be  refused.  Yet,  in  the  report  of  the 
New  York  Clearing-House  Association  for  the  period 
from  October  26,  1907,  to  March  28,  1908,  during  which 
the  gross  issue  of  certificates  during  the  panic  conditions 
was  $101,060,000,  collateral  of  the  various  classes  of 
assets  mentioned  above  was  used  as  security  for  the 
issue  of  certificates,  to  the  amount  of  $330,000,000  or 
72.92  per  cent  of  all  securities;  and  yet  not  a  dollar  was 
lost  in  that  whole  time  of  crisis  and  danger. 

In  conclusion,  if  the  loose  wording  of  the  act  were  in- 
terpreted as  has  been  claimed  above — and  no  other  seems 
possible — the  banking  paper  which  did  not  come  under 
the  legal  definition  of  "commercial  paper"  had  to  be 
accepted  as  security  for  notes;  it  had  to  be  accorded  the 
same  treatment  as  any  securities  (other  than  United 
States  bonds)  held  by  a  banking  association;  the  amount 
of  notes  issuable  on  such  banking  paper  (other  than 
"commercial  paper")  was  not  limited  to  30  per  cent  of 
the  capital  and  surplus;  and  notes  could  be  issued  to  the 
amount  of  75  per  cent  of  the  market  value  of  those  securi- 
ties. The  valuation  of  the  securities,  whether  bonds  or 
banking  paper,  and  the  decision  as  to  which  should  be 
accepted,  finally  rested  with  the  secretary  of  the  treasury. 
What  a  paradise  for  the  climbing  politician !  Soon  he 
became  active  in  obtaining  government  deposits  for  banks 


80  BANKING  PROGRESS 

in  his  district;  and  he  had  new  worlds  for  conquest  in 
pressing  local  securities  upon  the  magic  list  of  the  Trea- 
sury which  was  to  give  them  a  new  value  and  advertise- 
ment at  no  cost.  Certainly,  we  had  in  this  Aldrich- 
Vreeland  Act — the  product  of  a  few  days  struggle  at 
the  end  of  a  session — an  unexpected  freedom  of  issues 
based  on  banking  assets,  as  well  as  a  Pandora's  box  full 
of  unknowTi  possibilities  for  evil.  It  was  an  amazing 
lesson  on  the  folly  of  politics  in  banking. 


CHAPTER  V 
GUARANTY  OF  BANK-DEPOSITS 

j  §  1.  In  the  wake  of  a  financial  crisis  are  always  to 
be  found  numerous  proposals  to  give  the  monetary  world 
permanent  security.  Already  we  have  seen  how  the 
persistence  of  the  idea  that  panics  could  be  eliminated  by 
issues  of  paper  money  produced  legislation  in  1908  of  a 
hasty  character.  In  the  period  following  the  panic  of 
1907  public  attention  was  diverted  from  matters  touch- 
ing the  issue-function  to  matters  concerning  the  deposit- 
function  of  banks.  Out  of  this  discussion  much  was  added 
to  our  thinking  on  banking.  The  essential  purpose  of  a 
bank  is  to  lend.  If  the  loan  is  legitimate  and  the  security 
good,  the  bank  buys  the  right  to  receive  a  definite  sum  in 
the  future  and  gives  to  the  borrower  a  right  to  draw  on  de- 
mand. This  immediate  liability  which  the  bank  creates 
as  the  result  of  a  loan  may  take  either  of  two  forms, 
according  to  the  business  habits  of  the  community  and 
the  preference  of  the  borrower:  (1)  the  issue  to  the  cus- 
tomer of  the  bank's  own  notes  (or  other  cash) ;  or  (2)  the 
grant  to  him  of  a  deposit-account  for  the  amount  of  the 
loan  (less  the  bank  discount).  Hitherto  the  issue  of 
bank-notes  had  received  the  chief  attention.  It  is  inter- 
esting, therefore,  in  following  the  slow  steps  of  banking 
progress  to  note  that  the  next  development  came  in  con- 
nection with  the  deposit-function.  Such  a  shift  of  inter- 
est, even  though  it  may  have  produced  many  fallacious 
schemes,  pointed  toward  our  final  objective,  the  better 
organization  of  credit.  For  credit  works  mainly  through 
the  deposit-function.    This  new   agitation   we  owe,   as 

81 


82  BANKING  PROGRESS 

also  in  the  case  of  silver,  largely  to  the  activity  of  am- 
bitious politicians.  Although  we  have  many  serious- 
minded  statesmen,  still  a  measure  is  not  infrequently 
judged  by  its  power  to  gain  votes  for  the  partj^  in  power 
in  the  next  election.  Consequently^  the  candidate  for 
oflBce  is  eagerly  searching  the  field  for  schemes  which 
can  be  regarded  as  personal  belongings,  and  which  will 
appeal  to  uninformed  masses  quite  independent  of  their 
true  ethical  or  monetary  quality. 

Of  such  a  character  was  the  "rag  baby"  of  greenback 
days,  or  the  free  coinage  of  silver  of  more  recent  memory; 
and  the  last  member  to  be  added  to  this  motley  collec- 
tion is  the  guaranty  of  bank-deposits.  Its  appearance 
soon  after  the  financial  crisis  of  1907  found  honest  sup- 
porters, not  only  from  those  who  were  injured  by  the  in- 
ability to  withdraw  deposits  in  the  days  of  the  panic, 
but  also  from  those  who  believed  they  had  found  in  it 
a  means  of  preventing  panics.  Superficial  thinking  as 
to  panics,  and  little  understanding  of  the  actual  opera- 
tions of  banks,  have  provided  a  soil  in  which  the  proposal 
for  a  guaranty  of  bank-deposits  may  take  quick  root. 
In  the  interests  of  a  sound  basis  for  our  monetary  and 
banking  institutions,  it  is  well  w^orth  the  while  to  give  a 
searching  examination  to  a  scheme  which  has  been  pro- 
posed not  only  for  the  State  but  also  for  the  national 
banks,  and  which  has  already  become  law  in  several  of 
our  States.  It  cannot  be  regarded  as  a  dead  issue  so 
long  as  it  is  recommended  to  Congress  by  the  comptroller 
of  the  currency.^ 

§  2.  The  purpose  of  the  scheme  is  to  distribute  the 
losses  to  depositors  arising  from  bank  failures  among  a 
large  number  of  banks,  instead  of  allowing  them  to  fall 

»  See  Federal  Reserve  Bulletin,  May.  1918,  p.  429. 


GUARANTY  OF  BANK-DEPOSITS  83 

on  the  innocent  depositors  who  were  not  responsible  for 
them.  To  this  end  it  is  proposed  to  levy  a  tax  on  the 
bankers  to  create  a  fund  which,  in  charge  of  the  State, 
shall  be  used  to  pay  off  at  once  the  claims  of  depositors 
in  insolvent  banks.  Some  advocate  the  guaranty  of  the 
government  or  State,  others  lay  the  whole  burden  on  the 
banks,  aided,  perhaps,  by  an  initial  grant  from  the  gov- 
ernment. There  is,  however,  no  agreement  as  to  the 
actual  working  of  the  plan:  (1)  some  insist  that  its  essen- 
tial value  lies  in  saving  the  depositor  from  waiting  for 
his  funds  until  the  liquidation  of  the  bank's  assets; 
while  (2)  others  think  it  is  only  to  assure  the  depositor 
against  ultimate  loss,  in  case  the  assets  are  insuflScient 
in  the  last  resort.  There  is  a  difference  between  these 
two  objects:  the  former  provides  for  immediate,  the 
latter  for  ultimate,  redemption  of  deposits.  Arguments 
for  the  one  would  not  apply  to  the  other.  At  first,  the 
benefit  was  supposed  to  centre  about  the  ability  of  the 
depositor  in  the  failed  bank  to  cash  his  claim  at  the 
very  time  when  emergency  conditions  were  dangerously 
pressing  upon  him.  Hence,  he  should  not  be  crippled  by 
loss  of  his  means  in  a  time  when  he  must  meet  maturing 
obligations.  This  view,  however,  seems  to  have  been 
abandoned  as  untenable,  because  it  was  quickly  pointed 
out  that  in  the  panic  of  1907  deposits  of  more  than  $100,- 
000,000  were  tied  up;  and  to  pay  off  this  sum  on  demand 
would  have  required  an  accumulated  guaranty  fund 
much  larger  than  that  mentioned  by  any  of  its  advocates. 
The  Fowler  Bill  evidently  assumed  that  $25,000,000 
would  be  enough,  while  elsewhere  $50,000,000  was 
thought  sufficient.  On  the  other  hand,  if  the  fund  were 
intended  only  for  the  ultimate  redemption  of  depositors' 
claims,  it  would  not  prove  of  much  advantage  to  the 
man  in  the  hour  of  panic.    The  panic  and  the  vital  need 


84  BANKING  PROGRESS 

would  be  long  gone  by  before  the  claim  was  realized 
upon. 

In  proposing  to  guaranty  depositors  in  general  there 
is  an  obvious  lack  of  discrimination  in  faiHng  to  distin- 
guish between  depositors  in  savings-banks,  whose  assets 
must  necessarily  be  given  a  long-time  investment  char- 
acter, and  depositors  engaged  in  active  business,  who 
have  checking  accounts  at  commercial  banks  which  must 
always  keep  assets  in  cash  sufficient  to  meet  normal  de- 
mand requirements.  For  this  first  class  savings-banks 
under  the  laws  of  the  various  States  are  created;  but,  ob- 
viously, not  all  States  have  been  careful  in  providing 
safety  for  such  depositors.  These  small  depositors  are 
the  ones  usually  referred  to  when  pictures  are  drawn  of 
the  misery  entailed  upon  persons  who  could  have  had  no 
means  of  deciding  whether  one  bank  was  safer  than  an- 
other. The  protection  for  depositors  in  savings-banks 
(or  small  private  banks)  is  a  wholly  different  problem 
from  that  for  depositors  in  commercial  banks. 

It  is  for  this  first  class  that  government  postal  banks 
were  suggested  as  offering  absolute  safety.  Apart  from 
the  inevitable  difficulties  arising  from  the  investment  of 
hundreds  of  millions  of  dollars  by  government  officials, 
and  the  selection  of  securities — very  grave  difficulties — 
there  could  be  no  doubt  as  to  the  safety  provided  by  the 
State  for  all  depositors  who  would  be  thought  incapable 
of  intelligent  choice  of  a  bank  in  which  to  make  time-de- 
posits. Therefore,  government  postal  banks  should  re- 
move much  of  the  sentiment  manufactured  for  consump- 
tion among  the  small  depositors  of  the  country  in  favor  of 
the  insurance  of  bank-deposits.  Moreover,  by  caring  for 
this  class  of  persons,  who  might  be  victimized  by  unprin- 
cipled bankers,  the  case  for  the  guaranty  of  deposits  in 
commercial  banks  which  are  left  there  by  active  and 


GUARANTY  OF  BANK-DEPOSITS  85 

keen  business  men — who,  moreover,  usually  deposit  where 
they  can  also  get  loans — can  be  better  treated  by  itself. 
Nor  has  the  establishment  of  a  government  savings  sys- 
tem, in  my  judgment,  had  any  appreciable  effect  on  the 
sums  left  with  the  commercial  banks. 

The  real  question,  therefore,  has  to  do  with  com- 
mercial banks,  such  as  our  national  banks,  and  some  of 
those  created  by  the  States;  for  the  trust  companies  and 
State  banks,  while  carrying  on  savings  departments,  also 
strive  actively  for  the  business  of  commercial  banks,  and 
cannot  by  any  means  be  ignored.  Later,  however,  the 
national  banks  were  prevented  by  a  decision  of  national 
officials  from  joining  any  guaranty  schemes.  Yet,  in  the 
main,  the  national  banks  received  the  greatest  attention 
in  the  discussion.  The  point  was  raised  that  because  the 
national  banks  issue  notes,  the  insurance  of  these  notes 
by  a  guaranty  fund,  providing  for  their  immediate  re- 
demption, has  been  generally  admitted  as  desirable  and 
feasible;  even  though  their  ultimate  redemption  must  be 
secured  by  a  first  lien  on  assets  or  by  the  deposit  of  bonds. 
If,  then,  the  insurance  of  the  noteholder  is  regarded  as 
necessary,  why  not  extend  the  same  idea  to  the  depositor  ? 

§  3.  There  is,  however,  a  wide  difference  between  the 
position  of  the  noteholder  and  that  of  the  depositor. 
When  a  demand-liabihty  of  a  bank,  in  the  form  of  a  note, 
comes  to  be  used  as  money,  and  is  passed  from  hand  to 
hand  by  buyers  and  sellers  who  have  no  knowledge  what- 
ever of  the  standing  of  the  issuing  bank,  it  must  have 
universal  acceptabihty.  It  should  be  no  more  neces- 
sary for  each  receiver  of  the  note  to  stop  and  ascertain 
the  solvency  of  the  issuer  than  it  should  be  necessary 
for  the  receiver  of  a  gold  coin  to  stop  to  test  and  weigh 
the  fineness  of  the  metal  contained  in  it.    It  is  not  in 


86  BANKING  PROGRESS 

the  interest  of  the  bank,  but  in  the  interest  of  the  busy 
pubhc,  that  protection  is  thrown  around  the  issue  of 
notes.  In  its  work  as  a  medium  of  exchange  the  note 
often  goes  forth  to  a  great  distance  from  its  place  of  issue, 
and  often  remains  in  circulation  for  a  long  period  before 
being  returned  for  redemption.  It  is  quite  otherwise 
with  the  deposit-currency.  While  the  note  performs  a 
general  and  social  function,  a  deposit  arises  solely  from  a 
personal  and  voluntary  act.  Deposit-currency  can  never 
possess  such  a  universal  and  general  character,  because 
each  particular  check  must  always  submit  to  proof  of  the 
existence  of  funds  sufficient  to  meet  the  order.  The 
noteholder  is  usually  an  involuntary,  and  the  depositor 
a  voluntary,  creditor  of  the  bank.  The  use  of  a  deposit 
always  implies  recourse  to  a  bank  in  order  to  give  it  effect 
in  payment;  while  a  note  requires  no  proof,  no  indorse- 
ment, no  identification  in  estabhshing  its  right  to  move 
in  the  world  of  exchange.  The  depositor  selects  his  own 
bank  and  takes  the  risks  impUed  in  a  voluntary  choice, 
thus  becoming  responsible  for  his  act,  just  as  any  one  does 
who  gives  credit  to  a  buyer  or  lets  a  house.  Consequently, 
the  reasons  for  a  guaranty  of  the  notes  are  obvious; 
while  they  would  have  no  application  to  the  guaranty 
of  deposits.  If  it  be  said  that  depositors  are  often  ig- 
norant of  the  soundness  of  one  bank  as  compared  with 
another,  it  may  be  answered  that  such  an  excuse  might 
be  admitted  for  the  class  of  small  savings-bank  depositors, 
but  not  for  the  ordinary  man  of  business  who  deals  with 
a  commercial  bank.  There  are  abundant  means  for  find- 
ing out  the  standing  of  banks  in  any  city.  Or,  if  it  be 
said  that  no  depositor,  not  a  director,  knows  what  is 
going  on  on  the  inside  of  a  bank,  so  it  might  be  said 
that  a  seller  of  goods  on  credit  does  not  know  what  the 
distant  buyer  is  doing  with  his  purchased  goods,  for  which 
he  has  not  yet  paid. 


GUARANTY  OF  BANK-DEPOSITS  87 

§  4.  A  depositor  is,  of  course,  a  creditor  of  a  bank; 
that  is,  the  relation  of  a  depositor  to  a  bank  is  only  one 
of  many  other  relations  existing  between  creditor  and 
debtor.  Is  there  anything  peculiar  in  the  case  of  the 
depositor  which  sets  him  apart  from  all  other  creditors, 
who  have  voluntarily  entered  into  a  creditor  relation, 
and  which  entitles  him  alone  to  protection  against  the 
consequences  of  his  own  acts?  If  one  sort  of  creditor 
should  be  insured  against  the  usual  mischances  of  busi- 
ness, why  should  we  not  insure  all?  Why  discriminate 
in  favor  of  him  who  is  rich  enough  to  have  a  bank-deposit  ? 
A  humble  washerwoman  who  often  has  outstanding  debts 
which  she  cannot  collect  ought  to  be  insured  against  loss 
as  well  as  a  depositor;  she  has  little  means  of  knowing, 
except  by  bitter  experience,  whom  to  trust.  And  the 
same  might  be  said  of  the  cobbler,  the  milkman,  the 
grocer,  the  doctor,  the  merchant,  or  the  large  wholesale 
seller  of  dry -goods,  or  the  seller  of  any  other  article;  for 
they  have  accounts  against  others  for  which  they  need 
the  collections  as  well  as  the  depositor  in  a  bank — per- 
haps more.  Wliy  this  sudden  access  of  interest  in  the 
creditors,  when  in  the  silver  agitation  every  true  patriot's 
heart  was  burning  with  zeal  to  help  out  the  poor  debtor  ? 
Has  the  politician  exhausted  the  possibilities  of  sympathy 
in  the  debtor,  and  wishes  to  try  new  pastures?  Cer- 
tainly, the  proposal  to  insure  depositors  as  an  application 
of  a  general  principle  of  insuring  all  creditors  does  not 
seem  to  be  practical.  ' 

Pathetic  pictures  have  been  drawn  of  the  misery  cre- 
ated by  the  failure  of  a  private  State  bank  in  Chicago, 
the  Milwaukee  Avenue  Bank:  how  innocent  men  and 
women  lost  a  life's  savings;  how  foreigners  saw  their 
fortunes  disappear  before  they  had  become  settled  in  the 
new  land;   how  small  dealers  were  ruined;   how  some 


88  BANKING  PROGRESS 

became  insane  and  others  committed  suicide.  Then,  it 
was  added,  ahnost  the  whole  of  the  deposits  were  in  the 
end  paid  out  of  the  assets  by  the  receiver.  Hence,  if 
the  deposits  had  been  guaranteed  and  the  depositors  had 
been  paid  off  immediately,  all  this  misery  would  have 
been  saved.  No  one  would  depreciate  the  frightful  re- 
sults of  this  unpardonable  wrong-doing;  but  is  this  the 
only  kind  of  misery  to  be  cared  for?  And  should  the 
State  consciously  engage  to  care  for  all  such  cases  arising 
from  accident  or  fraud?  Let  us  turn  from  the  picture 
just  given  to  another.  An  honest  and  successful  dealer 
was  selling  goods  to  Southern  buyers  before  the  Civil 
War.  On  the  breaking  out  of  the  conflict  he  found  all 
his  outstanding  debts  uncollectible;  he  was  ruined;  his 
children  had  even  to  be  withdrawn  from  school  and  set 
to  work  for  their  bread;  and  this  man,  broken  down,  ended 
his  life  in  the  poorhouse.  He  lost  everything;  while, 
in  the  other  case,  depositors  who  waited  recovered  most 
of  their  deposits.  If  depositors  suffer  from  no  error  of 
their  own,  so  also  did  our  merchant  suffer  from  no  error 
which  he  could  have  repaired.  In  both  cases,  the  per- 
sons had  acted  voluntarily,  and  both  had  to  take  the 
chances  going  with  acts  of  their  own  choice.  When  all 
evil  and  possibility  of  misjudgment  have  gone  from  our 
world,  then,  and  only  then,  may  we  think  of  insuring  the 
whole  class  of  creditors,  including  the  depositor. 

There  is  no  justice  in  laying  the  depositor's  losses,  for 
which  he  is  not  responsible,  upon  others  who,  also,  are  not 
responsible  for  the  losses.  The  honest  and  efficient 
banks  cannot  in  justice  be  asked  to  make  up  to  a  depositor 
in  a  failed  bank  losses  for  which  the  honest  and  efficient 
banks  had  no  responsibility  whatever.  It  would  be 
clearly  unfair  to  hold  a  small,  conservatively  managed 
country  bank  responsible  for  the  "frenzied  finance"  of 


GUARANTY  OF  BANK-DEPOSITS  89 

some  large  bank  in  a  great  city.  All  reason,  all  justice, 
demand  that  the  punishment  be  inflicted  on  the  doer  of 
the  wrong  and  not  on  the  innocent  neighbor.  In  fact, 
the  ethical  justification  for  taxing  sound  banks  to  cover 
the  lapses  of  unsound  banks  has  no  existence  whatever. 
It  is  unmoral.  Moreover,  it  is  a  question  whether  the 
courts  should  enforce  such  a  law  against  the  rights  of 
property. 

§  5.  More  than  that,  it  is  not  supported  by  any 
theory  of  political  expediency  but  the  socialistic.  The 
advocates  of  insurance  deplore  the  suggestion  that  it  is 
socialistic,  and  are  as  much  horrified  by  the  mention  of 
sociahsm  as  the  devil  is  by  the  sight  of  the  cross;  and 
yet  what  does  the  analysis  show.'^  It  is  not  necessary 
to  explain  to  intelligent  readers  that  socialism  is  not  cor- 
rectly defined  by  saying  that  it  is  opposed  to  individual- 
ism; socialists  look  to  the  State  to  do  for  them  what 
they  admit  that  they  cannot  do  for  themselves  under  a 
system  of  free  competition.  They  charge  against  the 
forms  of  society  what  is  due  to  the  deficiencies  of  human 
nature,  assuming  that  a  change  in  the  forms  of  society 
will  change  elemental  human  nature.  The  failure  to 
hold  their  own  in  the  struggle  of  life  is  the  incentive  to 
socialistic  thinking.  Disagreeable  as  it  may  sound,  in 
reality  socialism  is  the  philosophy  of  failure.  To  be  asked 
to  be  relieved  from  the  ill  success,  or  risk,  of  one's  own 
business  ventures  is  of  the  very  essence  of  socialism.^ 
When  human  nature  has  changed  its  spots,  and  can  be 
trusted  to  go  straight  without  existing  incentives,  then 
without  expecting  a  depreciation  of  human  fibre  we  may 
begin  to  remove  the  dread  of  loss  from  those  who  make 
mistakes.     It  is  only  because  men  must  look  out  for 

^  See  Laughlin,  Latter-Day  Problems,  revised  edition,  chap.  II. 


90  BANKING  PROGRESS 

themselves  that  they  differ  in  business  fibre  from  women 
and  children  who  are  separated  from  the  world  of  com- 
petitive effort.  One  may  admit  all  the  distress  arising 
from  the  inabihty  of  the  depositor  to  draw  his  deposits 
in  cash;  and  yet  one  would  not,  as  a  consequence,  need 
to  demand  insurance  against  every  emergency  in  which 
misery  may  arise  from  the  hazards  of  business.  The 
essential  idea  in  the  scheme  for  guaranteeing  deposits  in 
commercial  banks — quite  apart  from  the  humble  savings- 
bank  depositor — is  to  relieve  a  man  from  the  responsi- 
bility for  using  bad  business  judgment;  and  it  is  based 
on  the  principle  of  freeing  men  from  the  results  of  all 
business  engagements  in  which  there  may  be  a  risk  of 
loss.  If  we  once  begin  on  this  principle,  we  must  care 
for  all  those  who  have  entered  into  the  relation  of  creditor 
to  another.  The  scheme  is  the  product  of  a  narrow 
mind  which  has  seen  only  one  superficial  phase  of  the 
problem,  and  which  has  hurried  to  a  general  conclusion 
without  having  studied  the  wide-reaching  effects  of  an 
enervating  and  impractical  policy. 

Indeed,  the  origin  of  the  guaranty  idea  is  traceable 
either  to  the  general  prejudice  against  banks  or  to  the 
attempt  to  make  men  good  by  law.  It  is  purely  popu- 
listic,  or  socialistic,  in  its  parentage.  On  the  one  hand, 
it  seems  to  be  based  on  the  belief  that  banks  are  rich  and 
ought  tol)ear  the  burdens  of  the  unsuccessful.  If  some 
banks  are  badly  managed,  then  make  the  whole  rich 
banking  fraternity  bear  the  losses.  Thus,  by  hook  or  by 
crook,  no  matter  whether  the  system  is  just  or  unjust, 
the  bankers  will  have  to  get  out  of  it  among  themselves 
the  best  way  they  can.  They  can  stand  it  better  than 
anybody  else.  Let  the  moral  question  go  hang.  In  the 
second  place,  the  plan  is  an  attempt  falsely  to  make  one 
banker  as  good  as  another  by  law,  when  we  all  know  that 


GUARANTY  OF  BANK-DEPOSITS  91 

by  nature  they  must  differ  with  differences  in  skill  and 
integrity.  The  supporters  of  the  guaranty  system  are 
evidently  appealed  to  by  the  socialistic  quality  in  it. 
The  unsuccessful  banker  may  have  a  grudge  against  the 
successful  one;  and  then  it  is  easy  to  get  favor  for  a  law 
which  would  help  them  to  escape  the  results  of  their  own 
failures  and  to  draw  down  to  their  own  level  those  who 
have  succeeded.  In  reality,  there  is  only  one  royal  road 
to  large  deposits:  that  lies  through  skill,  integrity,  good 
management,  and  time  enough  to  enable  the  pubHc  to 
learn  of  the  existence  of  these  qualities. 

§  6.  In  some  of  the  pleas  for  insurance,  deposits  are 
supposed  to  be  "all  the  money  people  possess,"  "the 
people's  cash,"  a  "huge  volume  of  money."  Since  this 
sum,  fabulously  large,  is  in  the  banks,  the  whole  business 
fabric,  it  is  assumed,  must  rest  upon  the  banks.  The 
onlj^  thing  which  sustains  this  critical  situation  is  supposed 
to  be  the  confidence  of  the  depositors  in  the  bank;  when 
time  of  stress  comes  this  confidence  gives  way  to  dis- 
trust, followed  by  a  scramble  for  cash.  Then,  says  the 
insurance  advocate,  do  that  which  will  establish  per- 
petual confidence  by  the  depositor  in  the  bank,  and  we 
shall  never  more  have  panics.  The  plan  is  so  compact, 
so  easy,  that  it  recalls  at  once  the  naive  method  by  which 
the  Chinaman  got  his  supply  of  roast  pig. 

Probably  it  has  never  occurred  to  such  theorists  to 
examine  the  payments  to  a  bank  by  depositors  in  any 
one  day.  If  they  had,  they  would  have  found  that  in 
large  cities  the  cash  paid  in  was  insignificant  in  amount 
compared  with  that  paid  in  in  checks  drawn  on  deposit- 
accounts.  Moreover,  the  deposit  item  in  the  national 
banks  now  moves  in  close  correspondence,  in  amount  and 
in  changes,  with  the  loan  item.    In  fact,  a  loan  is  im- 


92  BANKING  PROGRESS 

mediately  followed  by  the  granting  of  a  deposit  in  favor 
of  the  borrower.  That  is,  the  mass  of  deposits  in  com- 
mercial banks  are  largely  the  result  of  loans;  and  the 
creation  of  a  demand-deposit  following  a  loan  is  always 
accompanied  by  leaving  an  equivalent  value,  as  the  se- 
curity for  the  deposit,  in  the  assets.  The  loan  given  for 
carrying  wheat  or  cotton  30  or  90  days  creates  a  demand- 
deposit  which  can  be  drawn  upon  on  demand  by  the 
borrower;  but  the  assets  constitute  in  effect  a  claim  over 
the  wheat  or  cotton,  or  its  equivalent  value,  which  will 
issue  in  some  means  of  payment  in  30  or  90  days.  If 
the  goods  are  salable,  the  deposits  are  safe.  In  short, 
the  deposits  are  as  safe  as  the  assets  on  which  they  are 
based.  Provided  loans  are  based  on  commercial  paper, 
the  deposits  are  as  safe  as  the  quick  goods  passing  be- 
tween buyer  and  seller.  The  deposits,  therefore,  depend 
for  their  safety  upon  the  kind  of  assets  taken  by  a  bank 
for  a  loan;  they  do  not  depend  upon  an  abstraction  like 
"confidence."  To  secure  safety  to  the  depositor,  all 
attention  should  converge  on  the  quality  and  liquid  na- 
ture of  the  assets  in  the  loan  account.  In  order  to  have 
confidence,  we  must  primarily  see  to  it  that  loans  are 
made  with  good  judgment.  The  whole  matter  pivots  on 
this  consideration.  The  only  way  to  avoid  a  crisis  is  to 
avoid  expansion;  which  is  only  another  way  of  saying, 
avoid  taking  assets  which  will  not  certainly  protect  the 
deposits  when  liquidation  is  enforced. 

§  7.  When,  therefore,  insurance  of  deposits  is  pro- 
posed as  a  means  of  preventing  panics,  because  it  will 
secure  confidence,  we  are  confronted  with  a  singularly 
crude  understanding  of  the  causes  of  panics  and  of  what 
the  operations  of  a  bank  really  are.  Confidence,  of  course, 
has  its  place  in  these  matters;  but  we  can  have  confidence 


GUARANTY  OF  BANK-DEPOSITS  93 

only  if  there  is  a  basis  for  confidence.  If  freight  is  sent 
on  a  railway,  accidents  cannot  be  avoided  by  serenely 
leaning  back  and  assuming — after  Christian  Science 
methods — confidence.  If  the  railway  is  carelessly  man- 
aged and  poorly  equipped,  there  will  be  wrecks  and  de- 
struction of  freight,  no  matter  what  the  mental  attitude 
of  the  shipj>er  is.  But  then,  says  the  insurance  advocate, 
tax  all  the  railways  for  an  insurance  fund  to  pay  for  the 
losses;  and,  then,  notice  how  all  the  good  railways  will 
report  upon  the  bad  ones,  with  the  result  that  there  will 
be  no  more  accidents.  This  illustration  brings  forth 
the  gist  of  the  whole  question.  You  can  prevent  acci- 
dents and  losses  only  by  directing  your  discipline  to  men 
and  equipment;  you  can  secure  safety  by  correct  railway 
methods,  not  merely  by  requesting  confidence.  No,  say 
the  insurance  advocates,  establish  a  guaranty  against 
all  losses,  and  you  will  have  confidence,  no  matter  how 
badly  a  railway  conducts  its  service;  and,  if  good  rail- 
ways must  contribute,  they  will  see  that  the  bad  rail- 
ways have  no  more  wrecks.  Imagine,  in  practice,  the 
outcome  if  the  Pennsylvania  Railway  were  to  be  called 
upon  to  pay  for  damages  due  to  accidents  on  the  Erie 
or  on  the  Baltimore  and  Ohio.  The  Pennsylvania,  if 
well  and  safely  conducted,  has  enough  to  do  to  watch 
its  own  road,  to  say  nothing  of  a  road  over  which  it  has 
no  daily  and  direct  control.  If  the  poor  road  were  free 
from  all  responsibihty  for  damages  due  to  its  own  manage- 
ment, what  incentive  would  there  be  to  improve  its 
methods.'*  Insuring  the  goods  may  reimburse  the  ship- 
per, but  it  does  not  touch  the  internal  conduct  of  the  road. 
And,  if  a  good  road  gets  no  advantage  from  its  fine  road- 
bed, its  solid  bridges,  its  well-trained  force,  why  should 
it  keep  up  its  superior  condition?  If  it  does  not  gain 
traffic  by  its  superior  condition  over  an  inferior  road, 


94  BANKING  PROGRESS 

there  is  no  reason  for  expenditure  of  mind  and  money  in 
safeguards. 

The  parallel  between  the  railways  and  the  banks  is 
practically  complete.  Confidence  in  banks  can  be  due, 
not  to  external  forces,  like  insurance  of  any  losses  which 
may  occur,  but  to  internal  forces  directed  upon  the 
methods  of  business  management,  and  the  quality  of  the 
assets  which  serve  as  the  security  for  the  deposits.  If 
the  internal  management  is  careful  and  judicious,,  the 
deposits  are  safe,  and  we  can  have  confidence  in  their 
safety.  Moreover,  if  a  good  bank  gets  no  advantage 
from  its  sound  business  methods,  its  conservative  loans, 
its  skill  in  avoiding  losses,  and  its  experienced  staff,  why 
should  it  try  to  keep  a  superior  standard?  The  insur- 
ance idea  seems  to  be  that  we  can  have  confidence  in 
banks,  if  only  some  one  will  pay  the  losses.  This  is  as 
much  as  to  say,  we  are  not  afraid  of  fire,  even  if  incendi- 
aries are  about,  because  we  are  insured;  when,  in  truth, 
the  only  permanent  confidence  is  due  to  measures  which 
will  ehminate  the  incendiaries.  So,  in  banking,  every- 
thing is  secondary  to  the  character  of  the  banking  man- 
agement and  of  the  assets  in  the  loan  item. 

It  cannot  be  insisted  upon  too  strongly  that  the  effort 
to  create  confidence  and  prevent  panics  by  insurance  of 
deposits  is  taking  hold  of  the  wrong  end  of  the  problem. 
The  deposits,  as  has  been  said,  can  never  be  any  safer 
than  the  assets.  Therefore,  if  we  wish  to  create  con- 
fidence and  prevent  panics,  every  effort  should  be  directed 
to  securing  only  the  safest  kind  of  assets.  This  is  the 
crux  of  the  whole  matter.  To  talk  only  of  insurance, 
and  to  minimize  the  importance  of  the  quahty  of  the 
assets,  is  only  to  act  after  the  damage  is  done;  to  close 
the  stable-door  after  the  horse  is  gone.  To  take  away 
responsibiHty  for  banking  losses  is  the  very  thing  to 


GUARANTY  OF  BANK-DEPOSITS  95 

lower  the  quality  of  the  assets.  Of  course,  the  insurance 
advocate  will  say  that  insurance  will  bring  about  safer 
banking  methods;  but  of  that  more  later  on. 

The  insurance  theorists  probably  mean  that  their 
scheme  would  prevent  a  panic,  because  it  would  prevent 
a  run  on  any  bank  in  the  system.  One  would  be 
curious  to  know  upon  what  analysis  of  credit  opera- 
tions a  crisis  could  be  regarded  as  due  merely  to  the 
state  of  mind  which  leads  to  a  run  for  cash.  In  truth 
a  run,  a  lack  of  confidence,  is  a  consequence,  not 
a  cause,  of  panic  conditions.  It  is  a  consequence  of 
doubt  as  to  the  kind  of  business  the  banks  have  been 
doing;  it  is  a  consequence — as  has'  already  been  in- 
sisted upon — of  the  poor  quality  of  the  assets.  The  ex- 
istence of  a  crisis  and  distrust  comes  from  loading  up 
with  speculative  ventures  or  assets  which  have  lost  their 
basis  of  market  value.  Extravagance,  overconfidence, 
undue  expansion  of  trade  based  on  borrowing,  prices 
raised  to  an  undue  height  imder  a  fictitious  demand, 
speculation  for  rising  prices  of  goods  and  stocks  are,  if 
wide-spread,  the  causes  of  panics.  The  sudden  realiza- 
tion of  this  unsubstantial  credit,  when  tested  by  some 
unexpected  demand  for  liquidation,  brings  on  a  crisis. 
Every  experienced  man  of  affairs  knows  that  the  ma- 
terial for  a  financial  catastrophe  is  collected  by  previous 
years  of  overtrading,  and  expansion  of  credit;  and  that 
it  is  only  an  accident  whether  it  is  this  or  that  event 
which  touches  off  the  powder-magazine.  The  actual 
liquidation  in  the  months  following  the  panic  of  1907 
shows  upon  what  mistaken  calculations  many  of  our 
loans  were  based,  and  how  rotten  much  of  our  credit 
fabric  was.  The  Heinze-Morse  affairs  of  October,  1907, 
were  only  one  set  of  incidents  in  a  series  of  existing  weak- 
nesses, which  had  shown  their  appearance  as  early  as  the 


96  BANKING  PROGRESS 

previous  March.  Now,  when  the  assets  in  the  loan  item 
of  the  banks  have  only  a  fictitious  value,  when  they  lose 
their  liquid  quality,  it  is  childish  to  talk  about  creating 
"confidence"  by  legislation,  or  by  such  a  scheme  as  guar- 
anty of  deposits.  It  would  not  change  the  previous  ex- 
pansion of  credit.  A  run  is  merely  the  logical  sequence 
of  what  has  gone  before;  and  the  evils  of  the  past  need 
time  to  be  worked  out.  You  may  put  salve  on  the  spot 
kicked  by  a  mule,  but  the  salve  cannot  be  said  to  have 
prevented  the  kick. 

In  actual  fact,  if  a  bank  has  been  soundly  managed, 
if  its  assets  are  sound,  a  bank  cannot  fail,  even  if  a  run 
on  it  is  started.  "I  have  been  forty  years  in  the  busi- 
ness," says  one  of  the  most  successful  bankers  in  this 
country,  "and  I  cannot  recall  a  single  case  of  the  failure 
of  a  sound  bank  that  could  be  attributed  to  an  imwar- 
ranted  run  on  it  by  depositors.  If  its  assets  are  good, 
it  can  always  obtain  cash,  or  assistance.  If  soundly 
managed,  it  will  have  reserves  enough  to  meet  any  fool- 
ish run;   or  it  could  borrow  on  its  convertible  assets." 

Now,  we  have  a  right  to  ask,  in  what  way  could  a 
scheme,  which  would  lay  the  burdens  of  rash  banking 
upon  sound  banking,  stop  a  panic  due  to  causes  reaching 
back  into  the  past  ?  As  well  say  that  a  mustard  poultice 
appUed  to  a  fever  patient  had  prevented  his  having  had 
any  fever  at  all.  The  guaranty  fund  would,  in  fact,  not 
check  runs  at  all.  Why?  Because,  even  in  case  of  a 
run,  the  guaranty  fund  could  not  be  drawn  upon  until 
a  bank  had  failed.  Moreover,  if  there  were  a  guaranty 
fund,  and  if  runs  were  general,  and  many  banks  had 
failed,  the  main  body  of  depositors  could  not  get  their 
cash  immediately,  but  only  after  liquidation — sooner  if 
assets  were  good,  longer  if  assets  were  poor.  Unless  a 
fund  exists  large  enough  for  immediate  redemption  of  all 


GUARANTY  OF  BANK-DEPOSITS  97 

deposits  of  all  failed  banks  in  any  serious  crisis — an  im- 
possible supposition,  as  we  have  shown — then  the  de- 
positor must  know  that  some  delay  in  drawing  on  the 
guaranty  fund  would  be  inevitable.  If  so,  and  if  he  is 
filled  with  a  panicky  desire  to  have  his  money  at  once, 
such  a  depositor  will  try  to  withdraw  his  funds  just  as 
certainly  under  the  guaranty  scheme  as  he  would  do  it 
now.  In  brief,  as  a  result  of  our  analysis,  the  guaranty 
scheme  is  proved  to  be  founded  on  a  foolish  theory  of 
panics,  and  on  an  utter  misunderstanding  of  the  facts  of 
trade  and  banking. 

§  8.  If  the  advocates  of  deposit-insurance  are  really 
in  earnest  in  wishing  to  mitigate  the  effects  of  an  un- 
reasoning run  by  depositors — after  previous  conditions 
have  produced  a  crisis — let  them  carefully  consider  the 
reforms  needed  in  our  system  of  bank-note  issues.  When 
unfavorable  developments,  like  the  Heinze  and  Morse 
revelations,  created  a  suspicion  as  to  banking  soundness, 
then  suddenly  psychological  conditions  appeared  arising 
from  alarm  as  to  the  safety  of  deposits.  Would  a  guar- 
anty of  deposits  have  been  a  rational  cure  for  this  fear? 
Let  me  explain  briefly  the  situation  which  makes  a  run 
dangerous.  In  order  to  serve  the  public,  the  bank  gives 
a  borrower  present  means  of  payment  in  return  for  which 
the  bank  will  get  repayment  by  waiting  until  a  time  in 
the  future.  In  reality,  when  the  bank  gives  him  a  right  to 
draw  on  demand,  the  whole  risk  as  to  the  successful  issue 
of  the  transaction  falls  on  the  bank;  that  is,  the  bank 
virtually  insures  the  soundness  of  the  business  transac- 
tion on  which  the  loan  was  based.  Quite  effectively,  the 
banks  convert  the  value  of  salable  goods  into  a  means  of 
payment,  and  enable  a  borrower,  by  checks  on  a  deposit- 
account,  to  exchange  the  value  of  his  goods  for  other 


98  BANKING  PROGRESS 

goods  which  he  wishes  to  buy.  Obviously,  no  one  wishes 
cash,  since  he  loses  interest  on  it  so  long  as  it  is  in  his 
possession.  Hence,  when  affairs  are  normal,  men  do 
not  ask  for  cash,  and  banks  can  easily  keep  the  percentage 
required  in  the  legal  reserves.  This  explains  why  a  bank 
may  legitimately  have  $70,000,000  of  demand-deposits, 
and  yet  perhaps  keep  only  $18,000,000  of  cash  reserves. 
Now,  under  such  conditions,  what  happens  if  the  cus- 
tomers lose  their  heads,  and  all  ask  for  cash  ?  Of  course, 
all  could  not  get  it;  and  these  customers,  under  an  un- 
written law,  became  depositors  knowing  they  could  not 
get  it.  In  spite  of  the  superficial  impression  that  a  de- 
posit in  a  bank  is  cash,  it  is  not  so  in  reality;  and  it  could 
never  have  been  so  "nominated  in  the  bond,"  if  wanted 
all  at  once.  Nor  could  any  conceivable  guaranty  fund 
be  large  enough  to  provide  the  cash  at  once.  It  is  an 
utter  impossibility. 

But,  on  the  other  hand,  observe  that  the  whole  object 
intended  by  a  guaranty  of  deposits  could  be  gained  by  a 
safe  and  properly  elastic  note-issue — such  as  has  been 
proposed  in  various  currency  reform  bills.  It  would  en- 
able the  immediate  exchange  of  a  deposit-liability  into  a 
note-liability,  without  altering  the  relation  of  reserves  to 
demand-liabihties,  and  yet  retain  for  the  notes  the  same 
assets  as  security  which  previously  were  regarded  as  safe 
for  the  deposits.  Not  only  would  this  plan  not  diminish 
the  power  of  the  bank  to  lend,  but  it  would  save  its  re- 
serves of  lawful  money  from  being  drawn  upon,  and  thus 
even  increase  the  ability  to  lend  to  needy  borrowers. 
But  it  would  do  another  very  important  thing:  it  would 
quiet  the  psychological  conditions  leading  to  runs,  by 
enabling  the  bank  to  pay  out  its  own  obligations  in  a 
form  of  "money"  which  would  satisfy  the  desire  to 
hoard,  and  enable  trust  companies,  and  other  institu- 


GUARANTY  OF  BANK-DEPOSITS  99 

tions,  to  be  supplied  with  cash.  If  national  banks,  in 
the  crisis  of  1907,  had  been  able  to  reduce  demand-de- 
posits by  increasing  demand-notes,  in  the  same  propor- 
tion, they  would  have  been  able  to  meet  the  request  for 
pay-rolls,  and  for  the  cash  needed  in  ordinary  retail 
trade,  without  having  had  practically  to  suspend  pay- 
ment from  the  Atlantic  to  the  Pacific.  By  providing 
notes,  the  banks  would  not  have  obliged  business  houses, 
as  they  did,  because  of  the  suspension  in  that  crisis,  to 
withhold  their  daily  cash  receipts  and  not  deposit  them 
in  the  banks.  Moreover,  if  depositors  could  have  ob- 
tained notes  pro  tanto,  the  newly  bom  agitation  for  the 
guaranty  of  deposits  would,  in  all  probability,  have  never 
made  any  headway.  In  fact,  the  demand  for  a  guaranty 
of  deposits  might  have  been  directed  into  a  thoughtful 
demand  for  a  system  of  note-issues  which  would  have 
effectively  removed  the  difficulties  under  which  depositors 
labor  in  the  hours  of  a  panic. 

Still  further,  it  should  be  mentioned  that  these  new 
note-issues  should  in  no  respect  differ  in  color,  design, 
security,  or  wording,  from  notes  previously  issued  in 
normal  times.  In  a  crisis,  or  in  the  critical  conditions 
preceding  one,  or  in  any  emergency  of  the  money  market, 
it  should  not  be  necessary  to  go  out  with  a  brass  band  to 
inform  the  public  that  it  was  quite  time  to  get  into  a 
panic  because  special  emergency  notes  were  about  to  be 
issued. 

In  times  of  stress,  however,  the  depositor's  need  is  not 
the  most  important;  for  if  he  has  a  deposit  he  can  pay 
a  debt  by  a  check.  We  must  consider,  in  this  matter, 
not  the  banks,  but  the  great  business  public  who  need 
help.  The  fundamental  need  is  the  grant  of  a  loan,  or 
the  continuation  of  an  old  one,  which  gives  the  right  to 
draw  on  a  deposit.    In  a  panic  men  are  driven  to  liqui- 


100  BANKING  PROGRESS 

date,  to  throw  over  securities  to  meet  maturing  obliga- 
tions. A  loan  is  the  protection  from  ruin.  If  legitimate 
borrowers  can  get  loans,  the  worst  is  over.  It  is  need- 
less to  say  that  a  guaranty  of  deposits  does  not  in  any 
way  affect  the  ability  of  a  bank  to  lend  in  a  time  of  panic; 
therefore,  it  will  have  no  appreciable  influence  in  reliev- 
ing the  conditions  brought  on  by  a  collapse  of  credit. 
The  only  thing  that  it  can  do,  at  the  best,  is  to  save  the 
depositor  from  waiting  for  his  funds  during  the  time  of 
liquidation;  and  even  this  purpose  is  now  abandoned  by 
insurance  advocates  as  impossible.  The  real  alarm — 
and  the  one  which  needs  to  be  quieted — is  that  based  on 
questions  as  to  the  value  and  character  of  the  assets  of 
the  bank;  and  that  depends  upon  the  whole  manage- 
ment in  a  time  reaching  back  into  the  past. 

§  9.  The  plan  for  insurance  of  deposits  is  urged  by 
its  advocates  as  one  which  will  induce  more  careful  bank- 
ing, because  contributors  to  the  fund  will  be  more  vigilant 
in  acting  as  policeman  over  other  bankers,  and  stop 
illegitimate  methods  in  their  inception.  On  the  other 
hand,  its  opponents  claim  that  it  will  reduce  the  best- 
managed  to  the  level  of  the  worst-managed  banks,  and 
remove  all  premium  on  skill,  honesty,  and  ability. 

Apart  from  fraud  and  stealing,  what  is  bad  banking? 
Clearly,  it  is  the  lending  of  too  much  to  favored,  or  in- 
side, parties;  and  the  inability  to  know  good  from '.bad 
paper,  and  "quick"  from  tied-up  investments.  Every 
conceivable  reward  should  exist  to  bring  pressure  on  a 
banker  to  have  courage  in  declining  questionable  loans. 
The  moment  such  pressure  is  removed,  the  opportunity 
is  enlarged  for  taking  on  assets,  which,  at  the  first  real 
emergency,  will  crumble  in  value,  and  leave  the  deposi- 
tors unsecured  even  after  long  and  diflBcult  liquidation. 
Therefore,  to  relieve  the  banker  from  the  logical  conse- 


GUARANTY  OF  BANK-DEPOSITS         101 

quences  of  his  own  mistakes,  of  his  own  weaknesses,  is 
I  to  take  away  practically  the  only  real  safeguard  likely  to 
aflfect  human  nature  in  a  business  touching  the  trusts  of 
countless  jSnancial  interests.  The  result  of  such  a  guar- 
anty would,  in  my  opinion,  tend  to  put  a  premium  on 
the  "popular"  and  "obliging"  banker,  as  against  the 
careful  and  judicious  banker;  to  spread  throughout  the 
country  the  influence  of  men  who  care  more  for  bigness 
than  for  safety  in  their  accounts;  to  build  up  credit  un- 
supported by  legitimate  trade;  and  in  the  end  to  bring 
on  financial  convulsions  proportional  in  disaster  to  the 
extent  of  the  doubtful  banking.  Not  only  would  it  be 
unjust  to  ask  the  efl&cient  to  meet  the  losses  of  the  ineffi- 
cient, but  it  is  poor  policy  to  expect  the  inefficient  to  do 
that  for  which  they  are  unfit. 

An  essential  difference  between  banks  in  manage- 
ment, stability,  conservatism,  and  success  cannot  wisely 
or  justly  be  wiped  out,  without  losing  the  very  elements 
of  safety  and  permanence  in  our  business  relations.  A 
great  bank  with  a  large  capital  and  surplus  affords  a 
wider  margin  of  safety  to  deposits  than  can  be  afforded 
by  a  small  bank;  and  the  large  bank  will  draw  deposits 
for  these  very  reasons.  Moreover,  depositors  in  prac- 
tice keep  their  deposits  where  they  are  likely  to  be  able 
to  get  loans  from  time  to  time;  and  an  examination  of 
figures  in  any  commercial  bank  would  probably  show 
that,  during  any  given  season,  some  large  depositors  had 
been  owing  the  bank  about  as  much  in  the  form  of  loans 
as  the  bank  was  owing  the  depositors.  In  that  case,  in 
order  to  treat  both  sides  fairly,  would  it  not  be  just  to 
ask  the  depositors  also  to  insure  the  banks  against  loss 
from  loans.'*  In  fact,  if  the  argument  for  insurance  of 
deposits  has  any  validity,  then  the  same  system,  in  order 
to  treat  both  interests  in  question  with  equal  justice, 
should  be  extended  by  a  tax  on  all  borrowers  to  insure 


102  BANKING  PROGRESS 

the  bank  against  loss  from  unfortunate  loans.  If  this 
were  done  there  would  be  no  need  of  guaranteeing  de- 
posits; for  if  assets  were  safe,  deposits  would  be  safe. 
Indeed,  too  much  is  claimed  for  this  guaranty  of  deposits. 
All  the  gains  of  society  are  credited  to  it,  until  one  is  in- 
clined to  think  its  advocates  see  in  it  a  remedy  for  all 
the  imperfections  of  man. 

We  have  previously  explained  that  a  guaranty  system 
would  promote  bad  banking,  but  the  advocates  go  to 
the  length  of  asserting  that  it  would  positively  discourage 
reckless  banking.  In  what  manner  is  it  thought  it  would 
discourage  the  making  of  bad  loans?  By  proposing  to 
watch  the  paper  offered  to  banks?  Not  at  all.  What, 
then,  is  the  argument  for  this  pure  theory  ?  "Under  this 
plan  of  securing  the  depositor,"  says  Mr.  Bryan,  "the 
stockholder  loses  all  that  he  has  before  any  other  bank 
loses  anything.  Not  only  does  he  lose  all  his  stock,  he 
also  loses  the  penalty  that  the  law  fixes,  and  the  loss  of 
the  stock  and  the  penalty  are  enough  to  make  him  exer- 
cise care."  Is  it  possible  that  Mr.  Bryan  does  not  know 
that  under  existing  law  every  bank  must  itself  first  lose 
all  its  capital,  surplus,  undivided  profits,  and  stocklaold- 
ers'  liability,  if  it  is  guilty  of  gross  mismanagement,  be- 
fore the  depositor  loses  ?  ^  Then,  from  Mr.  Bryan's 
point  of  view,  just  as  things  are  to-day,  we  have  all  the 
conditions  to  insure  vigilance  just  as  well  as  if  we  had 
the  much-vaunted  guaranty  of  deposits.  The  only  feasi- 
ble guaranty  system  is  now  in  actual  use. 

Let  us  further  analyze  the  practical  working  of  this 
matter.  Suppose  a  bank  accepts  the  theory  of  its  ad- 
vocates that  the  guaranty  of  deposits  will  prevent  all 
runs;  that,  since  the  depositor  is  wholly  protected,  he 
will  not  withdraw  his  funds  in  a  crisis.  Obviously  a  plan 
which  makes  the  banker  think  there  will  be  no  demand 

1  See  Chapter  VI,  §  3. 


GUARANTY  OF  BANK-DEPOSITS         103 

for  cash  reserves  in  a  panic  will  take  away  the  necessity 
of  forcing  him  to  carry  only  such  assets  as  are  quickly 
and  surely  convertible  into  cash  in  an  emergency.  Under 
this  scheme  there  will  be  no  need  of  having  good  assets  to 
offer  to  outside  banks  for  assistance  when  hard  pressed. 
Thus,  from  another  direction  we  reach  the  conclusion 
that  the  plan  will  remove  the  safeguards  against  reckless 
banking. 

Since  the  guaranty  of  deposits  will  not  prevent  the 
materials  for  a  crisis  gathering;  since  it  will  not  advance 
sound  banking  methods;  since  it  is  unjust  to  legitimate 
bankers,  and  since  all  the  benefits  to  be  gained  by  it 
can  be  secured  by  a  proper  note-issue  (which  would  miti- 
gate runs),  or  by  better  methods  of  banking,  there  is  no 
great  reason  for  going  into  a  scheme  which  is  as  distinctly 
socialistic  as  this  one.  Moreover,  among  the  means 
within  our  reach  for  secm-ing  better  banking  is  the  im- 
provement of  national  bank  inspections.  Appointments 
as  inspectors  have  been  made  largely  for  political,  and 
not  for  expert,  qualifications;  nor  are  the  fees,  assign- 
ments, and  frequency  of  examinations  what  they  should 
be.  The  clearing-house  associations,  in  default  of  proper 
national  inspections,  and  also  to  aid  in  legitimate  bank- 
ing by  State  banks  and  the  trust  companies  clearing 
through  their  associations,  established  inspection  agencies 
of  their  own,  which  have  proved  remarkably  efficient  in 
securing  safety  to  the  community  from  failures.  Such 
action  is  worth  all  the  guaranty  schemes  ever  born  in 
giving  protection  to  depositors,  and  it  is  done  in  the  only 
businesslike  way  practicable.  The  example  set  by  the 
Clearing-House  Association  of  Chicago,  after  the  Walsh 
failure,  has  been  followed  in  other  cities. 

§  10.     It  is  said  that,  as  we  have  insurance  for  plate 
glass,  for  houses,  and  for  life,  we  can  rightly  have  insur- 


104  BANKING  PROGRESS 

ance  for  deposits.  That  is  clear:  we  agree.  In  life  in- 
surance the  man  whose  life  is  insured  pays  the  premium; 
he  never  asks  his  neighbor,  who  is  not  insured,  to  pay 
his  premium  for  him.  So,  to  make  the  case  parallel,  the 
depositor  should  pay  the  premium.  That  is  a  business, 
not  a  political,  proposal.  If  so,  companies  insuring  de- 
posits would  charge  a  high  rate  for  deposits  in  badly 
managed  banks  and  a  low  rate  in  well-managed  banks. 
That  would  very  soon  separate  the  sheep  from  the  goats. 

When  examined  from  the  point  of  view  of  technical 
insurance  principles,  the  guaranty  method  is  not  impos- 
sible of  treatment  for  the  hazard  incurred.  Any  uncer- 
tainty can  be  insured,  provided  the  premium  is  large 
enough.  It  is  said  that  companies  already  exist  ready 
to  insure  deposits  at  3^  of  1  per  cent;  but  they  evi- 
dently expect  to  choose  the  banks.  And  just  here 
arises  the  central  difficulty.  In  ordinary  fire  insurance, 
one  enters  it  voluntarily;  and  one  gets  a  different  rate 
according  to  differences  in  the  moral  and  physical  hazard. 
Yet  in  the  guaranty  of  deposits  all  banks  irrespective  of 
differences  in  management  are  forced  to  enter  the  scheme. 
If  a  group  of  banks  of  high  standing  voluntarily  chose 
to  insure  each  other's  deposits,  because  they  had  con- 
fidence in  each  other's  management,  that  would  be  a 
different  thing  from  the  plan  generally  proposed.  More- 
over, the  parallel  with  fire  insurance,  in  which  the  owners 
of  the  property  at  risk  pay  the  premium,  and  the  insur- 
ance of  deposits,  in  which  the  depositor  does  not  pay  the 
premium,  does  not  hold.  As  a  strictly  insurance  question, 
it  should  be  left  to  the  insurance  companies  and  the  de- 
positors. This  was  practically  the  outcome  reached  by 
the  Kansas  legislature,  which,  following  the  radical  action 
of  Oklahoma,  established  a  guaranty  of  deposits  by 
State  law. 

If  the  guaranty  is  desired  for  the  immediate  redemption 


GUARANTY  OF  BANK-DEPOSITS         105 

of  all  deposits  in  failed  banks  in  any  crisis,  a  very  large 
fund  in  cash  would  be  required.  For  deposits  in  national 
banks  alone,  a  5  per  cent  fund  would  be  about  $216,000,- 
000 — a  sum  too  large  to  be  allowed  to  lie  idle  in  cash.  If 
invested  in  bonds,  it  can  no  longer  be  regarded  as  availa- 
ble for  immediate  redemption.  In  fact,  the  aim  of  im- 
mediate redemption,  as  already  said,  seems  to  have  been 
dropped.  If,  on  the  other  hand,  the  guaranty  is  intended 
only  for  ultimate  redemption,  after  the  bank's  assets  have 
been  liquidated,  it  will  not  materially  change  existing 
conditions,  and  will  not  give  ardent  advocates  of  deposit- 
insurance  what  they  are  clamoring  for — the  inmiediate 
control  of  their  funds  in  failed  banks.  Of  course,  it 
might  be  said  that,  if  ultimate  redemption  were  assured, 
deposit-accounts  in  failed  banks  w^ould  become  negotiable, 
like  any  other  delayed  payments.  But  the  same  is  true 
now:  the  accounts  in  the  suspended  Knickerbocker 
Trust  Company  of  New  York  were  bought  and  sold  in 
1907;  and  the  price  should  properly  vary  with  the  time 
of  discount  and  the  risks  involved.  The  average  annual 
losses  to  depositors  in  national  banks,  after  complete 
liquidation,  have  been  remarkably  small,  or  only  }^o  of  1 
per  cent  for  forty-three  years.  This  fact  has  been  used 
to  prove  how  small  the  guaranty  fund  need  be.  But  if 
ultimate  redemption  is  accomplished  with  such  little 
loss,  there  is  not  so  great  a  need  for  a  fund  as  supposed. 
The  error  of  the  insurance  theorists  is  in  confusing  ulti- 
mate with  immediate  redemption,  and  arguing  that  if  a 
small  fund  is  needed  for  the  former,  the  latter  can  be  as 
easily  provided  for.     The  mistake  is  patent. 

§  11.  Finally,  the  appeal  to  history  gives  the  plan  no 
authority.  We  have  had  experience  with  a  guaranty  of 
deposits  in  New  York  under  the  Safety  Fund  Act,  of 
April  2,  1829.    The  conditions  of  the  country  and  the 


106  BANKING  PROGRESS 

understanding  of  banking  were  such  at  that  time  that 
the  lessons  from  that  experiment  cannot  have  very  much 
value.  There  was  then  held  only  one  reserve  for  both 
notes  and  deposits.  Expansion  of  loans  in  those  days 
meant,  in  the  main,  an  expansion  of  notes.  The  safety 
fund  was,  therefore,  a  protection  to  both  notes  and  de- 
posits, but  mainly  to  notes;  as  business,  however,  was 
then  largely  done  by  notes,  its  service  was  much  as 
would  be  rendered  to-day  by  a  guaranty  of  deposits. 
What  then  was  the  outcome  ?  The  fund  was  established 
by  levying  a  tax  of  3^  of  1  per  cent  on  the  capital  stock, 
until  a  fund  of  3  per  cent  was  reached.  After  eight  years 
the  fund  was  tested  by  the  crisis  of  1837,  when  there 
were  ninety  banks  in  operation  with  a  capital  of  $32,200,- 
000.  All  the  banks  stopped  payment,  and  the  act  itself 
was  suspended  for  a  year.  Again,  in  1840-1842,  the 
system  was  put  to  the  test  by  eleven  serious  bank  failures. 
Thereupon,  in  1842,  it  was  decreed  that  the  fund  should 
hereafter  be  used  only  for  the  redemption  of  the  notes  of 
failed  banks.  The  experience  of  Vermont  and  Michigan 
was  still  less  satisfactory.  In  brief,  as  a  guaranty  of 
deposits  such  a  fund  proved  a  signal  failure — although 
the  experiment,  as  I  have  said,  is  not  conclusive  for 
present  conditions. 


I 


CHAPTER  VI 
THE  DEPOSITOR  AND  THE  BANK 

§  1.  All  bankers  ought  to  welcome  the  discussion 
caused  by  the  proposal  to  guaranty  deposits,  because 
it  will  inevitably  bring  out  a  better  understanding  of  the 
vital  functions  of  banking  and  better  explain  the  true  ser- 
vices of  banks  to  the  community.  All  that  bankers  can 
desire  is  the  truth  about  their  business.  It  is  undoubt- 
edly clear  that  the  reason  for  there  being  any  question 
at  all  to  discuss  exists  in  the  misunderstanding  in  certain 
quarters  as  to  what  banks  really  do,  and  as  to  what  is 
essential  to  sound  banking  and  the  safety  of  depositors. 
There  can  be  a  wish  only  for  a  fair  field  and  a  full  dis- 
cussion. 

The  argument  in  favor  of  insuring  deposits  is  ad- 
dressed to  two  classes:  (1)  the  depositors,  and  (2)  the 
bankers  and  stockholders  in  banks.  In  this  order  we 
shall  further  discuss  the  subject. 

It  is  said  that  it  is  the  depositor  who  makes  banking 
profitable.  Here  appears  a  misconception  as  to  the 
banking  business.  In  reality,  deposits  are  only  the  raw 
materials  for  profits;  they  must  be  wisely  and  skilfully 
managed  or  there  would  be,  not  only  no  profits,  but  even 
losses.  To  have  a  profitable  result,  we  need  skilled  labor 
to  work  up  the  raw  materials,  not  only  in  industry,  but 
in  banking.  The  mere  existence  of  capital  does  not  in- 
sure profits;  everything  depends  upon  what  is  done  with 
the  capital.  Capital  is  often  badly  invested  and  lost. 
In  banking,  we  shall  see  that  practically  everything  de- 
pends upon  wise,  honest,  and  capable  management. 

107 


108  BANKING  PROGRESS 

Moreover,  since  the  days  of  the  Bank  of  Venice,  banks 
have  come  into  existence  as  a  means  of  satisfying  a  need 
of  the  business  pubhc.  Persons  deposit  in  banks  volun- 
tarily because  they  get  privileges  in  return:  sometimes 
interest  on  deposits;  collection  of  checks  deposited;  a 
chance  to  get  loans  where  deposits  are  kept;  and,  above 
all,  to  share  in  the  most  convenient,  least  expensive,  and 
most  generally  used  medium  of  exchange  ever  devised, 
by  which  payments  can  be  made  anywhere  in  the  land 
through  checks  drawn  on  a  private  account;  and  all  the 
expense  of  this  bookkeeping  is  usually  given  free  to  the 
depositor.  All  the  monetary  services  of  the  general 
government,  all  the  issues  of  every  kind  of  paper  money, 
do  not  begin  to  compare  with  the  service  rendered  to  the 
public  by  the  work  of  exchanging  goods  done  by  the  banks 
and  clearing-houses  through  checks  drawn  by  depositors 
on  their  accounts.  Take  that  away  from  the  depositors 
for  twenty-four  hours,  and  the  whole  trade  of  the  coun- 
try would  be  paralyzed;  and  yet  there  are  persons  who 
say  that  depositors  are  not  given  anything  in  return  by 
the  banks. 

§  2.  But  the  misunderstanding  of  commercial  bank- 
ing shown  by  the  advocates  of  a  guaranty  of  deposits 
goes  still  further,  when  they  demand  such  a  guaranty  on 
the  ground  of  justice  to  depositors:  that  they  ought  to 
have  a  place  wherein  they  could  leave  money  and  get  it 
again  whenever  they  want  it.  Now,  if  a  depositor  wishes 
none  of  the  privileges  of  a  checking  account  in  a  com- 
mercial bank,  he  can  put  his  money  in  a  safety -vault,  and 
get  it  again  whenever  he  wants  it.  In  a  commercial  bank, 
on  the  other  hand,  it  is  never  pretended  that  if  all  de- 
positors wanted  their  money  at  any  given  moment  all 
could  get  it.    Why.'^    Because  a  commercial  bank  could 


THE  DEPOSITOR  AND  THE  BANK       109 

not  exist  if  it  did  not  invest  a  large  part  of  the  funds  de- 
posited   with   it.     It    creates    deraand-habihties    to    an 

'  amount  equal  to  all  its  deposits,  but  it  tries  to  have 
paper  maturing  in  such  a  continuous  way  that  it  can 
meet  all  normal  demands  for  cash.  A  solvent  bank  can 
always  meet  cash  demands  if  given  suitable  notice  of 

J  what  is  coming.  Yet  the  agitator,  who  does  not  seem 
to  know  the  difference  between  a  safety-vault  and  a 
commercial  banl<:,  asks  for  what  is  humanly  impossible 
— as  a  matter  of  justice.  He  asks  that  banks  should 
receive  the  deposit,  but  in  the  same  breath  he  assumes 
that  they  should  never  do  anything  with  it.  Justice  is 
assured  when,  and  only  when,  the  banks  invest  in  sound 
assets;  and  all  depositors  can  secure  their  funds  only 
when  the  management  is  successful,  cautious,  and  con- 
servative. The  deposits,  in  short,  are  as  safe  as  the 
assets  are  good;  and  the  sum  and  substance  of  the 
whole  matter  is  to  be  found  in  the  character  of  the 
management.  We  come  back  to  this  truth  from  what- 
ever point  we  begin  our  researches. 

I  have  said  that  the  safety  of  the  deposits  depends 
upon  what  is  done  with  them.  A  considerable  part  of 
the  deposits,  as  is  well  known,  are  loaned  out.  Now,  if 
you  could  force  all  the  borrowers  of  a  bank  to  insure 
that  bank  against  losses  from  bad  loans,  you  would  give 
both  the  bank  and  the  depositor  absolute  safety.  But 
if  the  borrower  of  good  credit  declines  to  be  responsible 
for  the  borrower  of  poor  credit,  you  cannot  blame  the 
safe  banker  for  refusing  to  be  responsible  for  the  specula- 
tive banker. 

Yet  it  may  be  said  that  commercial  banks  have  a 
quasi-public  function;  that  depositors  are  innocent  of 
the  inside  doings  of  banks;  that  when  the  banks  in- 
vest deposits  they  put  them  out  of  reach  of  the  de- 


110  BANKING  PROGRESS 

positor;  and  that  too  much  is  asked  when  the  depositor 
is  required  to  trust  to  the  soundness  of  the  investing 
judgment  of  bank  oflBcials.  It  is  further  added  that  when 
the  authorities  of  a  government,  State,  or  city  deposit 
with  banks,  some  special  security  for  the  deposit  is 
given;  and  that  if  a  bank  exacts  security ^from  the  bor- 
rower, the  bank  should  give  security  to  ^the  depositor. 
If  a  State  or  city  exacts  security  for  its  deposits,  it  is 
the  subject  of  a  special  contract  between  the  depositor 
and  the  bank  in  which  the  deposit  is  made.  If  a  private 
depositor  wishes  to  make  a  similar  special  arrangement 
with  a  bank,  he  can  do  so.  But  now  mark  just  where 
the  guaranty  advocates  miss  the  point.  They  are  not 
urging  that  each  bank  should  guaranty  its  own  de- 
positors, but  that  a  sound  bank  should  guaranty  de- 
positors that  it  never  heard  of,  in  a  bank  over  whose 
management  it  has  never  had  the  slightest  control. 
That  is  unjust.  It  is  near  to  robbery.  To  this  case  is 
joined  the  proposition  that  the  very  existence  of  banks 
organized  under  a  national  act  gives  a  presumption  to 
the  trustful  public  that  such  banks  are  sound;  and,  if 
so,  the  government  should  see  to  it  that  the  depositors 
are  made  absolutely  safe. 

§  3.  In  serious  fashion  let  us  look  this  case  squarely 
in  the  face.  Apart  from  the  great  privileges  given  by 
the  banks  to  depositors — already  described — do  the 
banks  recognize  the  fact  of  their  quasi-public  function, 
and  that  they  must  give  security  to  their  own  depositors 
for  exercising  good  judgment  in  making  loans,  with  the 
knowledge  that  the  stockholders  will  suffer  a  heavy  loss 
in  case  of  error  or  fraud  ?  The  answer  unequivocally  is, 
they  do.  In  fact,  the  lapse  disclosed  by  the  advocates 
of  insurance  of  deposits  in  no  part  of  their  argument  ap- 
pears more  obvious  than  in  not  knowing  that  the  banks 


THE  DEPOSITOR  AND  THE  BANK       111 

now  put  up  a  very  large  fund  as  a  security  for  their  de- 
positors. 

There  are  only  two  possible  ways  of  using  a  guaranty 
fund:  either  for  (a)  ultimate,  or  for  (6)  immediate  re- 
demption of  deposits.  Let  us  consider  ultimate  redemp- 
tion first  on  the  assumption  that  a  guaranty  of  de- 
posits should  be  urged  on  national  banks.  Is  it  con- 
ceivable that  the  political  orators  do  not  know  that 
there  is  already  a  guaranty  fund  for  the  ultimate  pay- 
ment of  deposits  ?  The  capital,  surplus,  and  undivided 
profits  of  every  national  bank  is  the  buffer  between  the 
depositor  and  loss.  Only  after  the  mis  judgment  of  a 
bank  has  destroyed  its  capital,  surplus,  profits,  and 
shareholders'  hability  can  the  depositor  suffer  loss.  Is 
this  effective,  in  fact  ?  That  it  is  effective  is  disclosed  by 
the  figures,  quoted  even  by  the  guaranty  advocates, 
that  the  loss  to  depositors  in  over  forty  years  of  the 
national  bank  system  is  only  )^6  of  1  per  cent  per  annum. 
Here,  then,  we  have  final  and  complete  proof  that  the 
banks  actually  do  insure  their  depositors  at  the  risk  of 
great  loss  to  themselves.  On  May  14,  1908,  the  amount 
of  this  ultimate  guaranty  fund  was  as  follows,  for  the 
6,778  national  banks: 


Capital $912,361,919.59 

Surplus 555,000,248.14 

Undivided  profits 203,108,414.78 

Stockholders'    liability ' 273,000,000.00 

Total $1,943,470,582.51 


*  Although  the  shareholders'  liability  is  legally  equal  to  the  capital  stock 
held  ($912,361,919.59),  yet  it  is  well  known  that  actual  collections  fall  short 
of  the  legal  total.  Shareholders  may  have  no  other  attachable  property  than 
their  shares.  The  aggregate  capital  of  insolvent  banks,  finally  liquidated, 
was  $59,622,420;  assessments  levied,  $36,246,390;  collections  from  assess- 
ments, $17,616,404.  Thus  the  percentage  of  actual  collections  to  capital 
was,  in  round  numbers,  about  30  per  cent.  Cf.  Table  73,  Report  of  the  Comp- 
troller of  the  Currency,  1907.  The  figures  for  this  year  are  typical  and  serve 
as  well  as  those  for  any  later  years  to  illustrate  the  principle. 


112  BANKING  PROGRESS 

Omitting  deposits  in  the  national  banks  by  the  govern- 
ment and  disbursing  ojQBcers  to  the  amount  of  about 
$180,000,000,  which  were  covered  by  bonds,  the  private 
deposits  amounted,  at  the  same  date,  to  $4,313,656,789.59. 
Therefore,  the  insurance  fund  for  all  the  banks  amounted 
to  about  45  per  cent  of  all  the  private  deposits.  This 
shows,  of  course,  that  when  a  depositor  is  considering 
the  selection  of  an  individual  bank  in  which  to  deposit, 
he  gets  a  larger  security,  other  things  being  equal,  from 
those  having  the  largest  capital,  surplus,  and  undivided 
profits. 

But,  an  objector  may  say,  the  banks  themselves  keep 
this  fund  in  their  own  hands  and  invest  it  just  as  they  do 
deposits.  Of  course  they  do;  but  even  if  there  were  a 
shrinkage  of  50  per  cent  in  the  assets  there  would  on 
liquidation  still  remain  a  cash  fund  of  about  $1,000,000,- 
000,  or  more  than  twenty  times  as  large  as  any  sum  pro- 
posed by  the  advocates  of  a  guaranty  fund.  It  is  all 
available  for  the  ultimate  liquidation  of  deposits.  More- 
over, in  Oklahoma,  the  State  redeposited  the  guaranty 
fund  with  the  banks. 

§  4.  Next,  let  us  consider  (6)  immediate  redemption. 
No  one  has  gone  to  such  an  extreme  as  to  propose  the 
segregation  of  a  fund  large  enough  for  the  immediate  re- 
demption of  all  deposits.  In  fact,  the  withdrawal  of 
any  large  sum — even  5  per  cent  of  deposits — from  the 
banks  to  any  depository,  where  it  would  remain  un- 
invested, is  purely  chimerical;  and,  if  invested  in  bonds, 
it  would  be  of  no  use  as  a  cash  fund  for  instant  use. 

Immediate  redemption  in  cash  is  impossible,  in  any 
serious  crisis,  because  cash  is,  by  the  very  nature  of  a 
crisis,  out  of  reach.  In  the  panic  of  1907,  the  closed 
banks  in  New  York  alone,  as  has  been  before  mentioned. 


THE  DEPOSITOR  AND  THE  BANK       113 

-  had  deposits  of  about  $100,000,000.  During  that  panic, 
where  in  this  country  could  that  sum  in  cash  have  been 
obtained  ?  And  this  says  nothing  of  the  closed  banks  at 
that  time  in  the  rest  of  the  country.  Even  the  Treasury 
of  the  United  States  did  not  have  enough.  In  fact,  it 
was  itself  in  a  panic  and  planning  to  get  the  banks  to 
come  to  its  aid  when  duties  fell  off. 

If  other  than  the  failed  banks — the  latter  having  been 
badly  managed — had  been  called  upon,  when  the  needy 
business  public  were  pressing  them  for  loans,  to  put  up 
this  cash  out  of  their  own  resources — in  addition  to  the 
demands  from  country  banks  in  the  interior — the  panic 
would  have  spread  destruction  far  and  wide.  Such  a 
guaranty  system  would  have  aggravated  every  evil. 
That  is,  just  when  sound  banks  were  stretching  every 
nerve  to  save  legitimate  business  concerns,  they  would 
have  had  theii*  reserves  reduced  enormously,  solely  to 
cover  the  mistakes  of  unsound  banks  for  whose  conduct 
they  could  in  no  sense  be  held  responsible. 

§  5.  In  view  of  the  small  loss  to  depositors  in  over 
forty  years  of  the  national  bank  system — as  if  that 
were  not  in  itself  a  complete  answer  to  their  argument — 
the  advocates  of  a  guaranty  fund  showed  a  further  mis- 
conception as  to  banking  operations  by  saying:  If  this 
loss  is  so  small,  why  not  go  further  and  give  us  absolute 
security  ? 

As  if  anything  in  human  affairs  is  capable  of  absolute 
certainty.  Men  are  not  yet  perfect;  and  mistakes  may 
be  made  in  our  judgments  as  to  the  outcome,  not  only  of 
business,  but  even  of  political  expectations.  A  bank  does 
business  with  fallible  human  beings.  A  borrower  of  a 
bank,  when  in  the  midst  of  important  operations,  may 
die;  or  a  house  borrowing  of  a  bank  may  have  an  em- 


114  BANKING  PROGRESS 

bezzling  official  and  be  crippled;  or  a  general  financial 
depression  may  unexpectedly  cut  off  collections  and  oblige 
banks  to  continue  loans  rather  than  force  failures — and 
yet,  in  view  of  all  these  things,  the  banks  are  asked  to 
give  absolute  security.  Why  not  ask  a  clergyman  on 
becoming  a  pastor  of  a  church  to  give  absolute  security 
that  no  one  in  his  flock  will  ever  tell  a  lie,  commit  an  error 
in  conduct,  or  go  to  hell-fire  ?  WTiy  not  make  the  doctors 
give  a  guaranty  that  no  patient  shall  ever  die? 

Banks,  or  any  other  business  enterprise,  cannot  promise 
absolute  security.  Take  the  case  of  a  steamship  company. 
It  requires  cash,  or  security,  for  tickets  from  its  passengers; 
yet  it  cannot  possibly  give  absolute  security  to  them. 
It  does  a  transporting  business  dealing  with  uncertain 
elements  in  nature  and  human  beings;  it  can  only  do  its 
best  in  overcoming  the  dangers  of  the  sea  with  the  best 
obtainable  seamanship  and  good  management.  The  pas- 
sengers on  a  steamer  and  the  owners  of  the  steamer  are 
equally  interested  in  not  having  the  steamer  sink.  Even 
then,  in  spite  of  every  precaution,  there  are  losses.  So 
it  is  with  banks.  There  are  inevitable  risks  involved  in 
lending  idle  funds  deposited  in  banks  to  the  active  men 
who  use  them  in  productive  industry.  There  always 
will  be  risks,  so  long  as  men  are  fallible.  That  manage- 
ment is  best  which  makes  the  least  mistakes.  If  absolute 
security  is  required,  commercial  banks  must  become 
safety-deposit  vaults.     There  is  no  other  alternative. 

§  6.  Thus  far  we  have  taken  up  the  arguments  in 
favor  of  guaranty  of  deposits  addressed  specifically  to 
the  depositors,  as  if  they  were  at  present  not  receiving 
their  rights;  and  we  have  shown  these  arguments  to  be 
based  on  a  misconception  of  banking  and  business  opera- 
tions.   Now,  we  may  next  pass  to  the  points  addressed 


THE  DEPOSITOR  AND  THE  BANK      115 

directly  to  the  self-interest  of  the  bankers  themselves,  in 
order  to  make  them  favor  a  guaranty. 

As  is  well  known,  the  scheme  to  insure  deposits  re- 
quires all  banks,  good  and  bad,  jointly  to  contribute  to 
a  fund  to  pay  off  depositors  in  failed  institutions.  The 
more  successful  the  bank,  the  larger  its  deposits,  the 
more  it  must  pay  into  the  fund;  the  less  successful  a 
bank  is  in  impressing  the  public  with  its  security  and 
the  smaller  its  deposits,  the  less  it  pays  into  the  fund. 
The  successful  are  to  pay  for  the  mismanagement  of  the 
unsuccessful.  Let  us  illustrate.  If  burglar  A  robs  B's 
house,  go  to  the  most  honest  man  in  the  village,  C,  and 
rob  him  to  pay  for  B's  loss — it  will  increase  the  eager- 
ness of  all  men  to  be  honest  and  discourage  burglary ! 
C,  the  successful  man,  will  enjoy  paying  for  B's  care- 
lessness in  keeping  no  locks  on  his  house;  and  if  C  has 
to  pay  for  all  the  deviltry  in  the  town  it  will  stimulate 
others  to  get  honest  so  that  they  can  pay  for  similar 
losses.  As  C,  who  had  nothing  to  do  with  the  case,  is 
penalized,  and  not  A,  the  burglar,  the  plan  will  discourage 
burglary.  The  scheme  is  perfect;  it  might  work  per- 
fectly— in  an  insane  asylum.  Mr.  Bryan  has  well  said, 
and  we  must  all  agree  with  him:  "One  of  the  things  I 
want  to  see  adopted  in  the  form  of  regulation  [of  banks] 
in  the  near  future  is  the  law  that  will  put  the  penalty  on 
the  right  man  and  not  on  the  community."  If  the  Eng- 
lish language  conveys  its  meaning  clearly,  those  words 
mean  that  he  favors  penalizing  the  man  who  cheated  his 
depositor  by  bad  loans  and  not  the  man  who  protected 
his  depositor  by  safe  loans.  If  that  is  the  case,  it  is 
only  logical  to  suppose  that  Mr.  Bryan  was  radically  op- 
posed to  the  guaranty  of  deposits. 

But,  say  the  guaranty  theorists,  depositors  really  suf- 
fer from  bank  failures;  and  the  only  way  to  prevent  this 


116  BANKING  PROGRESS 

suffering  is  to  make  such  a  combination  of  all  banks  as 
will  force  the  good  banks  to  watch  the  bad  banks,  know- 
ing that  the  good  banks  must  pay  the  losses  unless  they 
prevent  failures.  A  combination  of  this  kind  is  not,  of 
course,  founded  on  equality  and  co-operation.  It  is  a 
plan  by  which  the  depositor,  in  case  he  makes  a  mistake 
in  choosing  his  bank,  will  have  an  innocent  bank  pull 
the  chestnuts  out  of  the  fire  for  him.  Of  course  the 
sound,  well-managed  bank  would  never  draw  on  the 
fund;  it  is  put  up  solely  for  the  weak  ones. 

Let  us  for  a  moment  analyze  the  theory  that  the  guar- 
anty of  deposits  would  oblige  the  sound  banks  to  watch 
the  unsound  ones,  and  thus  cause  better  banking.  Is  it 
possible  for  good  banks  to  prevent  other  banks  from 
making  bad  loans  ?  The  fact  that  a  bank  is  doing  ques- 
tionable banking  is  known  only  after  loans  are  made. 
Then,  how  can  you  prevent  the  initial  act?  Obviously, 
only  by  establishing  a  central  organization  of  the  best 
bankers  who  should  pass  on  every  application  for  credit 
before  it  is  given  by  other  and  smaller  banks.  But  that 
is  impossible,  visionary.  Such  a  remedy  would  be  re- 
garded by  the  smaller  bankers  as  worse  than  the  disease. 
It  would  be  like  creating  a  trust,  or  a  "money  octopus." 
In  providing  what  is  an  impossible  remedy  for  depositors 
in  time  of  failure,  it  would  amount  to  creating  a  means 
which  would  really  destroy  existing  credit  facilities.  If 
mice  trouble  the  housekeeper,  you  would  not,  in  the  hope 
of  killing  the  mice,  import  a  tiger  that  would  devour  the 
very  housekeeper  herself. 

In  truth,  the  only  way  to  control  the  initial  act  of  each 
bank  when  making  a  loan  is  by  increasing  in  every  pos- 
sible way  the  rewards  to  sound  and  conservative  bank- 
ing. It  cannot  be  done  by  saying  that,  if  bad  loans  are 
made,  the  penalty  for  them  shall  fall,  not  on  the  unwise 


THE  DEPOSITOR  AND  THE  BANK      117 

banker  who  made  tlieni,  but  on  the  innocent  and  wise 
bankers  who  had  nothing  whatever  to  do  with  the  bad 
loans.  That  is  dangerous  poHtical,  as  well  as  banking, 
morals.  If  good  management  is  made  to  pay  for  the 
evils  of  bad  management,  there  will  be  taken  away  the 
rewards  for  sound  banking  and  all  reason  for  the  growth 
of  skill  and  integrity.  To  suggest  that  sound  banks 
should  pay  the  customers  of  unsound  banks  in  cases  of 
failure  puts  the  responsibility  and  penalty  on  the  wrong 
persons,  and  violates  every  principle  of  justice  and  fair- 
ness between  men. 

Every  banker  knows  that  a  bank  permanently  gains 
deposits  only  by  impressing  the  business  public  with  a 
belief  in  its  influential  connections,  in  its  foresight  in 
meeting  financial  emergencies,  and  in  its  wise  and  skilful 
management.  The  depositor  is  properly  influenced  by 
these  considerations.  But  under  a  scheme  of  guaran- 
teeing deposits,  what  would  be  the  effect.'^ 

Bankers  of  doubtful  judgment  and  integrity  would 
find  themselves  relying  on  the  guaranty  fund  (supplied 
mainly  by  other  banks)  as  a  means  of  attracting  deposits, 
instead  of  trying  to  attract  them  by  the  exercise  of  skil- 
ful management.  As  a  result,  the  deposits  of  the  coun- 
try would  be  changed  from  a  method  of  distribution 
based  as  now  on  relative  estimates  of  wise  management, 
to  another  and  artificial  method  in  which  soundness  of 
management  would  play  no  part.  Under  this  false  system 
deposits  would  inevitably  be  got  by  those  who  are  less 
skilled  and  honest  than  those  who  now  hold  them.  That 
is  exactly  what  the  plan  is  contrived  to  do.  The  funda- 
mental mischief  in  the  scheme  is  that  it  is  based  on  the 
theory  that  all  men  in  the  banking  business  are  equally 
honest  and  efficient.  A  theory  based  on  such  an  error 
can  never  be  supported  by  any  but  specious  arguments. 


118  BANKING  PROGRESS 

The  appeal  is  sometimes  made  to  small  banks  that  a 
compulsory  insurance  fund  including  all  banks,  large  and 
small,  will  put  the  small  on  the  same  level  as  the  large 
banks,  so  far  as  accumulating  deposits  is  concerned.  In 
brief,  it  is  an  appeal  to  select  a  bank,  not  on  the  strength 
of  its  management,  but  on  the  fact  that  bad  management 
will  be  paid  for  by  "the  other  fellow."  That  is,  banks 
willing  to  accept  this  appeal  are  by  that  very  fact  to  be 
distrusted;  for  they  are  soliciting  business  on  the  theory 
that  they  are  to  be  trusted  not  because  of  their  sound 
banking,  but  because  of  a  system  under  which  they  can 
escape  due  responsibility  for  losses.  Bankers  who  would 
advertise  an  insurance  fund  to  attract  deposits  obviously 
advertise  the  fact  that  they  do  not  expect  to  receive  de- 
posits primarily  on  their  record  as  careful  bankers. 

The  guaranty  theorists  even  insist  that  successful 
banks  now  oppose  an  insurance  law,  because  they  wish 
to  take  advantage  of  the  insecurity  of  badly  managed 
banks,  and  to  draw  deposits  away  from  them.  Of  course 
they  do.  Why  not.^*  Should  not  an  honest  man  glory 
in  his  honesty  and  deserve  the  rewards  which  the  com- 
munity deal  out  to  honesty  .f*  Does  not  an  honest  and 
upright  lawyer  win  a  larger  practice  over  an  incompetent 
shyster  for  exactly  those  reasons.'^ 

§  7.  As  an  example  of  what  has  just  been  explained, 
we  have  the  Oklahoma  experiment.  Some  of  the  banks 
of  this  State  sent  out  cards  showing  the  increase  of  their 
deposits.  Two  causes  were  supposed  to  be  at  work: 
(1)  the  cessation  of  hoarding,  and  (2)  the  relatively  supe- 
rior safety  of  Oklahoma  banks,  as  contrasted  with  those 
having  no  insurance  deposits.  As  regards  the  first  cause 
(1),  there  was  no  evidence  whatever  but  general  opinion 
regarding  the  amount  of  money  hoarded  and  the  amount 


THE  DEPOSITOR  AND  THE  BANK      119 

that  came  out  of  hoards.  The  very  word  "hoarding** 
impHes  secrecy  and  the  absence  of  knowledge  about 
sums  or  places.  But  the  rapid  movement  of  men  and 
capital  to  the  exceptional  resources  of  an  undeveloped 
region  was  in  itself  enough  to  account  for  increasing 
deposits. 

As  regards  the  second  cause  (2),  doubtless  some  minds 
were  influenced  by  i  e  existence  of  a  guaranty.  One 
speaker  exulted  ov3r  the  case  of  an  Illinois  man  who 
withdrew  $6,000  frcm  an  Illinois  bank  and  deposited  it 
in  one  in  Oklahoma  in  order  to  be  more  safe.  Under  any 
system,  however,  there  are  good  and  bad  banks.  No 
doubt  there  were  some  banks  in  Illinois  to  be  distrusted; 
and  the  sound  Illinois  banks  would  not  wish  to  be  held 
responsible  for  them.  And  the  same  was  true,  of  course, 
of  Oklahoma.  If  a  guaranty  system  will  prevent  bank 
failures,  why  is  it  that  already  in  Oklahoma  failures  have 
taken  place  .f*  Of  course  there  is  nothing  whatever  in 
the  claim,  so  sensationally  put  forth,  that  a  guaranty  of 
deposits  will  prevent  failures.  There  will  be  good  and 
bad  banking  in  Oklahoma  under  a  guaranty  system.  If 
it  were  not  certain  that  there  would  be  bad  banking  there, 
then  why  was  the  act  passed  ?  Solely  to  make  the  good 
pay  for  the  bad.  No  legislation  will  make  every  banker 
in  Oklahoma,  or  anywhere  else,  honest  and  skilful. 
Some  are  certain  to  be  weak  and  ineflScient  under  any 
system.  The  whole  question  is :  Who  shall  pay  for  their 
mistakes?  Obviously,  we  all  agree  with  Mr.  Bryan  in 
insisting  that  the  penalty  shall  be  put  "on  the  right  man 
and  not  on  the  community."  The  "right  man"  is  clearly 
not  the  man  who  has  won  success  in  gathering  deposits 
by  the  exercise  of  honor  and  discretion  in  his  business. 
And  no  amount  of  special  pleading  can  induce  us  to  put 
the  penalty  on  him.    But  the  guaranty  of  deposits  is, 


120  BANKING  PROGRESS 

by  its  very  nature,  intended  to  put  the  penalty  on  him. 
And,  finally,  the  attorney-general  has  ruled  that  national 
banks  cannot  go  into  the  business  of  insuring  other  bank- 
ers, since  it  is  a  business  foreign  to  their  banking  charters. 
Consequently  a  ruling  in  accordance  with  that  opinion 
has  been  made  by  the  comptroller  of  the  currency.^  It 
is  for  the  depositor,  not  the  bank,  to  seek  an  insurance 
company  chartered  to  take  such  risks. 

§  8.  Not  having  any  substantial  basis  in  knowledge 
of  proper  banking  operations,  the  guaranty  scheme  has 
been  ingeniously  urged  upon  bankers  because  of  the 
peculiar  relations  of  national  banks  to  State  banks.  Of 
course  a  federal  law  would  not  cover  the  action  of  State 
banks,  and  vice  versa.  Now  it  is  proposed  to  urge  the 
federal  guaranty  law  on  the  ground  that,  in  any  one 
State,  such  as  Oklahoma,  Kansas,  or  Nebraska,  a  State 
guaranty  law  would  force  the  national  banks  to  come 
in  or  lose  their  deposits.  Hence,  the  only  way  to  pro- 
tect the  national  bankmg  system  against  the  encroach- 
ments of  one  or  several  States  is  to  pass  a  federal  law  for 
a  guaranty  of  all  national  bank  depositors. 

(1)  Suppose  a  national  guaranty  law  were  passed. 
Then,  on  the  theory  of  its  advocates,  the  deposits  would 
leave  the  banks  in  all  States  having  no  guaranty  law 
and  go  to  the  national  banks.  In  that  case,  the  law  would 
work  an  injury  to  every  honest  State  bank.  Obviously, 
then,  the  State  bankers  ought  to  be  opposed  to  the 
scheme,  so  far  as  their  interests  are  affected.  But,  say 
the  guaranty  theorists,  in  that  case  every  State  would 
be  obliged  to  pass  a  guaranty  law  also.     If  that  fol- 

^  For  further  information  on  the  Oklahoma  and  other  experiments,  see 
Thornton  Cooke,  Quarterly  Journal  of  Economics,  November,  1909,  and  Feb- 
ruary, 1910;  and  The  Guarantee  of  Bank  Deposits,  by  T.  Bruce  Robb,  soon  to  be 
published  (1920). 


THE  DEPOSITOR  AND  THE  BANK       121 

lowed,  of  course  the  State  and  national  banks  would 
stand  relatively  to  each  other  just  where  they  do  now; 
and  there  would  be  no  gain  to  any  bank  in  either  class. 
The  result  would  be  nil,  except  that  good  banks,  both 
State  and  national,  would  now  have  to  carry  the  losses 
of  bad  banks. 

But  (2)  suppose  some  States,  like  Oklahoma,  Texas, 
Kansas,  and  Nebraska  adopted  a  guaranty  system. 
Then  other  States,  having  a  more  just  view  of  their  duty 
to  careful  banking,  might  not  adopt  it.  As  a  conse- 
quence we  should  have  as  endless  a  confusion  as  exists 
now,  for  instance,  between  State  bankruptcy  laws. 
Hence,  are  clear-headed  business  men  in  other  States, 
with  their  eyes  open,  likely  to  urge  a  law  certain  to  create 
a  confusion  in  business  relations  with  correspondents  in 
different  States  compared  with  which  present  conditions 
would  be  like  paradise  .^^     I  think  not. 

In  order  to  force  bankers  to  accept  a  guaranty  law, 
however,  a  threat  had  been  made  that,  if  they  did  not, 
they  must  expect  a  postal  savings  law.  Here  the  argu- 
ment was  addressed  to  the  fear  of  losing  deposits.  Those 
who  thought  this  threat  formidable  obviously  failed  to 
distinguish  between  a  savings-bank  and  a  commercial 
bank.  The  adoption  of  a  postal  savings  law  affected,  in 
the  main,  only  the  uninformed  small  depositors  who  hoard, 
or  who  distrust  the  local  savmgs-bank.  In  the  nature  of 
things  such  a  system  could  not  attract  the  large  mass  of 
deposits  left  with  the  commercial  banks  by  active  busi- 
ness men,  for  one  overwhelming  reason.  A  true  com- 
mercial bank  exercises  both  the  functions  of  deposit  and 
discount — the  issue-function  not  being  essential.  Now, 
if  a  depositor  is  in  trade,  or  if  he  is  one  who  may  need 
loans,  he  is  by  that  fact  estopped  from  keeping  his  funds 
with  a  government  postal  agency,  from  which  he  cannot 


122  BANKING  PROGRESS 

borrow  on  short  time.  Exactly  because  the  government 
is  not  a  bank,  and  ought  not  to  be,  it  will  not  receive  the 
checking  accounts  which  are  generally  left  with  banks 
on  the  understanding  that  credit  will  be  given  when 
needed. 

Therefore,  when  a  guaranty  advocate  rises  to  a  rhetori- 
cal climax  by  threatening  the  banks  not  only  with  the 
loss  of  small  savings-accounts — which  are  not  profitable 
to  a  bank,  anyway — but  also  the  probable  extension  of  the 
savings-deposit  limit  from  a  beginning  at  $500  to  a  higher 
limit,  which  would  include  the  checking  accounts  of 
merchants,  he  is  not  likely  to  carry  conviction. 

§  9.  Finally,  the  worst  monetary  fallacy  in  the  argu- 
ments of  the  guaranty  theorists  is  involved  in  the  claim 
that,  if  established,  the  system  would  draw  so  much 
money  into  the  banks  as  to  remove  all  necessity  for  cre- 
ating an  emergency  note  circulation.  The  error  here  is 
in  confusing  property,  or  goods,  with  the  medium  of  ex- 
change by  which  the  goods  are  exchanged.  No  matter 
how  much  actual  coin  is  hoarded,  no  matter  the  cause 
which  brings  it  out  into  bank  reserves — the  actual  de- 
posits then  require  only  the  usual  proportion  of  reserves; 
and  when  the  banks  reach  that  proportion,  extra  coin 
is  disposed  of  just  as  quickly  as  a  farmer  sells  his  surplus 
wheat.  After  that,  banking  goes  on  just  as  before  the 
arrival  of  the  hoard.  But  what  next.-*  If  a  panic  ap- 
pears next,  there  would  be,  as  a  consequence,  just  the 
same  demand — be  it  more  or  less — for  an  elastic  emer- 
gency circulation  after  the  establishment  of  a  guaranty 
system  as  there  would  have  been  before.  An  emergency 
in  business  conditions  due  to  an  overexpansion  of  credit 
will  come  and  go  for  reasons  entirely  dissociated  with  the 
insurance  of  deposits — that  is,  if  we  may  suppose  that 


THE  DEPOSITOR  AND  THE  BANK       123 

human  nature  as  it  now  acts  remains  the  same  after  such  a 
system  is  put  into  operation.  In  fact,  the  idea  that  the 
quantity  of  money  in  existence  is  of  chief  importance,  as 
distinct  from  the  quantity  of  salable  goods  on  which  loans 
and  deposits  are  based,  is  but  the  old  greenback  fallacy  in 
a  new  disguise.  It  overlooks  the  clear  truth  that  as  sala- 
ble goods  increase  there  is  increased  the  basis  for  legit- 
imate loans  by  banks;  that  these  loans  result  in  deposits 
on  which  checks  are  drawn;  and  that  thus  the  banks 
are  constantly  affording  a  deposit-currency  to  the  public 
as  an  elastic  medium  of  exchange.  Let  those  who  think 
an  elastic  and  enlarging  currency  is  desirable  begin  to  be 
grateful  to  the  marvellous  service  rendered  by  the  de- 
posit-currency of  the  banks  in  exchanging  over  $250,000,- 
000,000  of  goods  every  year.  Greenbacks,  and  even 
bank-notes,  are  far  behind  in  this  comparison  of  work 
done  by  our  different  media  of  exchange. 


CHAPTER  VII 
BANK-NOTES  AND  LENDING  POWERS 

§  1.  In  the  panic  of  1907  it  was  impressed  on  the 
pubhc  and  on  Congress  that  our  monetary  system  was 
not  of  the  kind  that  could  successfully  withstand  the 
stress  of  a  monetary  stringency  or  the  greater  dangers 
of  a  serious  financial  collapse.  These  impressions  led 
to  a  wide-spread  demand  for  monetary  reform,  to  the 
appointment  by  Congress  of  the  National  Monetary 
Commission  (1908),  and  to  the  publication  by  this  com- 
mission of  a  great  mass  of  material  on  money  and  bank- 
ing. These  volumes  may  have  helped  in  the  education 
of  Congress,  but  because  of  their  bulk  they  were  not 
likely  to  help  very  much  in  the  education  of  the  public. 
It  is  clear,  however,  from  these  volumes  and  from  knowl- 
edge previously  in  our  possession  that  the  lessons  to  be 
had  from  other  countries  as  well  as  from  our  own  must 
inevitably  be  drawn  upon  in  framing  concrete  proposals 
to  Congress.  Moreover,  under  our  political  methods,  it 
was  not  a  question  as  to  what  outside  experts  might  pro- 
pose, but  what  the  leaders  in  Congress  thought  could  be 
passed  through  both  Houses  under  the  existing  conditions 
of  public  opinion  (educated,  of  course,  as  far  as  possible). 
This  situation  we  have  had  to  keep  in  mind  in  all  our 
discussions.  The  lessons  to  be  got  out  of  these  volumes 
and  the  inferences  from  them  applicable  to  conditions 
in  the  United  States  could  without  doubt  be  very  simply 

^  This  chapter  may  have  some  interest  due  to  the  fact  that  it  was  written  in 
November,  1910,  at  the  time  when  the  plans  for  the  Federal  Reserve  Act  had 
not  yet  been  framed. 

124 


BANK-NOTES  AND  LENDING  POWER    125 

presented,  K  so,  and  if  made  intelligible  to  the  general 
public,  there  was  a  good  chance  that  they  could  be  im- 
pressed upon  Congress  and  enacted  into  law. 

Of  course  we  have  to  beware  of  the  man  with  a  cut- 
and-dried  system,  who  has  a  beautiful  theory  sure  to 
prevent  all  panics  and  to  cure  all  the  ills  of  industry. 
As  in  the  case  of  any  disease,  we  must  first  find  out 
accurately  what  is  wrong,  and  next  try  to  discover  a 
remedy  to  meet  the  particular  ill.  First,  then,  as  to 
the  difficulties  disclosed  in  the  past  which  must  be 
overcome  by  a  correction  of  our  monetary  system.  At 
that  time  (1910)  Secretary  MacVeagh  by  his  urgent  sug- 
gestions to  the  national  banks  to  organize  currency  asso- 
ciations under  the  Aldrich-Vreeland  Act  of  March  30, 
1908,  in  order  to  be  prepared  for  an  expansion  of  bank- 
notes in  case  of  an  unexpected  emergency,  consciously 
or  unconsciously  indicated  his  belief  that  monetary  and 
credit  emergencies  could  be  met  by  the  issue  of  bank- 
notes. On  the  other  hand,  if  his  words  were  correctly 
reported,  the  chairman  of  the  National  Monetary  Com- 
mission expressed  the  belief  that  the  problem  was  not  so 
much  one  of  circulation  as  it  was  one  of  the  organization 
of  credit.  The  problem  seems  to  shift  between  bank- 
notes on  the  one  hand,  and  the  power  of  a  bank  to  lend 
on  the  other;  (1)  the  needs  of  the  public  for  currency 
and  (2)  the  needs  of  a  bank  when  under  pressure  in  meet- 
ing demands  for  loans. 

§  2.  The  needs  of  the  public  for  currency  to  act  as  a 
medium  of  exchange  in  buying  and  selling  goods,  in  pay- 
ing wage-rolls,  in  travel,  etc.,  are  obvious.  In  certain 
sorts  of  transactions,  mainly  in  retail  trade  and  in  dis- 
tricts unused  to  banking  methods,  some  form  of  money 
must  be  passed  from  buyer  to  seller.    In  total  amounts. 


126  BANKING  PROGRESS 

however,  these  transactions  are  insignificant  in  com- 
parison with  those  on  a  large  scale  which  are  carried  on 
by  checks,  drafts,  or  bills  of  exchange — without  the  use 
of  any  forms  of  ordinary  money.  With  an  increasing 
population,  but  chiefly  with  the  increasing  products 
bought  and  sold  at  retail,  the  demand  for  currency,  such 
as  it  is,  must  increase  absolutely  in  greater  or  less  sums. 
For  such  needs  an  elastic  bank-note  circulation,  slowly 
rising  but  expanding  and  contracting  sharply  with  sea- 
sonal demands,  is  imperative.  Our  old  national  bank 
circulation  did  not  provide  for  this  elasticity.  It  ex- 
panded and  contracted  without  any  direct  relation  to 
the  demands  of  the  community.  To  this  point  of  elas- 
ticity much  emphasis  has  been  directed,  and  its  im- 
portance should  not  be  minimized;  but  it  is  to  be 
doubted  if  it  is  as  vital  as  some  suppose.  If  we  used 
only  bank-notes  (or  other  paper  money)  as  a  medium  of 
exchange  the  insistence  upon  an  elastic  bank-note  cir- 
culation would  be  of  first  importance;  and  even  in  the 
limited  field  in  which  actual  money  is  imperative,  the 
need  of  an  elastic  bank-note  issue  to  the  general  public 
remains  highly  important.  But  since  we  have  as  a  me- 
dium of  exchange  a  deposit-currency  which  is  perfectly 
elastic,  elasticity  of  note-issues  should  receive  attention 
only  in  the  proportion  of  the  importance  of  bank-notes 
to  other  media  of  exchange,  under  normal  conditions  of 
business. 

Still  keeping  in  mind,  however,  the  needs  of  the  public 
for  a  medium  of  exchange  and  not  the  needs  of  the  bank 
itself,  it  may  possibly  appear  to  many  that  the  demand 
of  the  public  for  expanding  issues  of  currency  is  of  vital 
importance  in  a  time  of  financial  distress,  such  as  was 
that  in  the  autumn  of  1907.  To  those  who  set  most 
store  by  the  virtues  of  an  elastic  bank-note  issue  this 


BANK-NOTES  AND  LENDING  POWER    127 

seems  the  crux  of  the  whole  matter.  It  is  supposed  that 
in  a  time  of  stringency  the  public  will  demand  more  cir- 
culation ;  and  to  support  this  view  the  events  of  the  panic 
of  1907  have  been  drawn  upon  as  proof.  It  is  true,  of 
course,  that  greenbacks,  silver  certificates,  or  bank-notes 
could  not  be  had  in  most  cities  during  the  height  of  the 
panic  in  1907,  even  in  small  sums;  and  as  a  consequence 
the  clearing-house  associations  issued  clearing-house  notes 
(as  distinct  from  clearing-house  loan  certificates)  for  cir- 
culation among  the  public.  Without  doubt,  this  inability 
to  get  cash  for  a  small  check  on  a  bank  or  at  a  paying 
office  made  a  deeper  impression  on  the  minds  of  the  peo- 
ple than  any  other  event  during  the  panic.  It  was  the 
belief  in  the  need  of  more  money,  based  on  this  experience, 
to  which  Congress  evidently  catered  when  it  passed  the 
Aldrich-Vreeland  Act,  as  a  provisional  measure  before 
a  coming  election  in  1908.  It  was,  as  every  one  must 
admit,  a  striking  commentary  on  the  inadequacy  of  our 
banking  and  monetary  system  that  it  was  impossible  for 
the  banks  to  supply  to  employers  of  labor  and  for  the 
small  needs  of  every  day  a  relatively  small  amount  of 
currency  having  a  general  circulation.  Yet,  on  the  other 
hand,  it  is  a  fact  that  the  total  amounts  of  the  clearing- 
house notes  issuvd  for  the  use  of  the  public  were  not 
large,  nor  were  they  long  outstanding.  Moreover,  as 
affecting  the  ability  of  the  producing  and  trading  houses 
to  weather  the  stress  of  the  panic,  they  had  practically 
no  influence  whatever.  The  banks  were  more  fright- 
ened than  the  public.  The  demands  of  the  small  local 
banks  for  additional  precautionary  reserves  drew  down 
the  cash  reserves  of  city  banks  more  than  did  the  de- 
mands of  business  men.  This  was  the  reason  for  the 
scarcity  of  circulation.  The  holding  on  to  their  cash  by 
city  banks  was  primarily  in  the  interest  of  reserves,  and 


128  BANKING  PROGRESS 

therefore  in  the  interest  of  those  who  might  possibly  wish 
loans  or  who  had  to  be  carried  for  a  time. 

The  power  to  expand  their  note-issues  (which  are  lia- 
bilities) could  not  have  added  directly  to  the  cash  re- 
serves of  the  banks  and  thus  have  enlarged  their  power 
to  aid  needy  borrowers.  It  is  true,  however,  that  an 
expansion  of  note-issues  would  have  aided  the  banks  in- 
directly; it  would  have  allowed  them  to  satisfy  the  urgent 
demand  of  the  public  for  a  medium  of  exchange  by  pass- 
ing out  their  notes  and  thus  would  have  enabled  them  to 
retain  lawful  money  which  could  be  used  as  reserves  to 
support  their  loans  and  deposits.  But,  primarily,  the 
issue  of  bank-notes  is  for  circulation  in  the  hands  of  the 
public  and  not  for  any  serious  advantage  which  they 
render  in  increasing  the  power  of  the  bank  to  lend  and 
to  stave  off  a  panic.  Accordingly,  the  prevailing  idea 
that  we  must  provide  against  future  panics  and  avoid  a 
repetition  of  what  happened  in  the  panic  of  1907  by  ar- 
ranging for  the  rapid  issue  of  bank-notes  in  a  time  of 
emergency  is  quite  aside  from  the  real  point;  for  it  is 
based  on  the  wrong  assumption  that  it  is  the  lack  of  cur- 
rency in  the  hands  of  the  public,  and  not  the  difficulty 
of  the  banks  in  lending,  which  is  the  critical  thing  at 
such  a  time. 

This  popular  insistence  on  the  view  that  we  can  pre- 
vent the  occurrence  of  panics  and  meet  all  the  dangers 
of  a  financial  panic  once  it  is  upon  us  by  the  device  of 
an  expansion  of  bank-notes  is,  in  my  judgment,  based 
on  an  erroneous  analysis  of  banking  operations  in  times 
of  pressure.  Very  respectable  authorities  have  asserted 
that  our  monetary  system  is  radically  at  fault  so  long  as 
it  will  not  prevent  the  occurrence  of  panics.  And  the 
belief  that  the  Bank  of  England  or  the  Bank  of  France 
— as   central   institutions — have  been   able  to   head  off 


BANK-NOTES  AND  LENDING  POWER    129 

speculation  and  avert  the  evils  of  expanded  credit  have 
been  referred  to  as  instances  of  what  could  be  done  by  a 
central  institution  in  this  country.  We  have  been  led 
to  think  that  the  issue  of  notes  was  the  means  by  which 
the  dangers  of  the  crisis  were  met  and  its  inconveniences 
reduced;  in  the  case  of  England  by  the  suspension  of  the 
Bank  Act  bringing  out  more  notes  from  the  issue  de- 
partment; and  in  the  case  of  France  directly  by  the  in- 
crease of  notes  of  the  Bank  of  France.  As  we  shall  see 
later  this  appeal  to  the  banks  of  England  and  France  is 
wholly  unfounded  in  fact. 

The  reserve  city  bank  which  can  quickly  increase  its 
own  notes  can  supply  the  demands  made  upon  it  by 
country  national  banks  and  correspondents — provided 
the  country  bank  wishes  currency  only  for  circulation  in 
its  neighborhood  and  not  for  its  own  reserves.  Here, 
again,  the  new  bank-issues  do  not  give  the  pivotal  aid 
which  some  suppose  always  comes  from  additional  cir- 
culation. Not  being  lawful  money,  they  could  not  be 
used  in  reserves  and  therefore  would  not — and  could  not 
I  — improve  the  lending  power  of  the  local  country  bank. 
They  would,  however,  as  we  have  seen,  supply  currency 
to  the  country  bank  which  could  be  paid  out,  if  urgently 
demanded,  and  thus  indirectly  protect  reserves. 

Another  advantage  in  emergency  bank-notes,  of  course, 
is  the  use  that  can  be  made  of  them  by  national  banks 
having  relations  with  State  banks  and  trust  companies. 
By  issuing  their  own  notes  they  may  exchange  them  for 
lawful  money  held  by  banks  outside  the  national  system. 
In  this  way  they  can  indirectly  increase  their  lawful 
money  and  consequently  their  power  to  lend. 

All  the  above  advantages  are  patent  and  are  argu- 
ments in  favor  of  a  margin  of  elastic  note-issues.  But 
..  such  issues  have  only  a  limited  importance  and  would 


ISO  BANKING  PROGRESS 

not  cure  the  fundamental  diflSculties  existing  in  times  of 
panic.  The  principal  reason  for  this  statement  exists  in 
the  fact  that,  obviously,  the  bank  cannot  replenish  its 
reserves — which  are  an  asset — by  an  addition  to  its  own 
notes,  which  are  a  liability.  Apart  from  its  illegality  it 
is  a  banking  lie. 

Moreover,  the  use  of  its  cash  resources  in  the  direct 
purchase  of  any  kind  of  bonds  or  securities  to  be  de- 
posited for  the  protection  of  its  emergency  notes  would 
not  only  not  improve  but  really  reduce  the  power  of  a 
bank  to  lend  and  thus  reduce  its  ability  to  aid  needy 
borrowers.  A  sum  of  $100,000  in  lawful  money  in  the 
reserves  would  support  loans  and  consequent  checking 
accounts  of  from  $400,000  to  $600,000  when  borrowers 
are  calling  for  help — provided  borrowers  used  checks  as 
a  means  of  payment.  Therefore,  a  bank  would  cripple 
itself  should  it  invest  $100,000  of  lawful  money  in  securi- 
ties in  order  to  issue  only  $100,000  of  note-issues — thus 
allowing  loans  of  only  the  same  amount — provided  bor- 
rowers used  notes  as  a  means  of  payment.  Consequently, 
no  system  of  note-issues  based  on  the  purchase  of  securi- 
ties by  lawful  money  would  touch  the  centre  of  the 
need. 

Finally,  too  much  is  made  of  the  need  of  an  elastic 
bank  circulation  in  a  time  of  panic  in  view  of  the  fact 
that  we  already  have  a  perfectly  elastic  medium  of  ex- 
change in  our  deposit-currency,  especially  for  all  large 
transactions.  The  term  "money"  is  loosely  used.  We 
use  gold  as  a  standard,  but  we  do  not  use  it  to  any  appre- 
ciable extent  as  a  medium  of  exchange.  More  than  95 
per  cent  of  our  large  transactions  are  performed  by  a 
check  and  deposit  currency  which  rises  and  falls  exactly 
in  proportion  to  the  exchanges  of  goods  which  call  forth 
loans  and  bank-deposits.    Under  existing  familiar  methods 


BANK-NOTES  AND  LENDING  POWER     131 

of  payment  by  checks  and  drafts,  the  borrower  who  is 
able  to  get  a  loan  in  a  time  of  stress  has  no  difficulty 
whatever  in  meeting  his  maturing  obligation  by  a  check 
on  a  solvent  bank.  To  get  the  loan  is  the  important 
thing — not  the  particular  form  of  liability  which  the 
bank  gives  him  on  making  the  discount.  In  fact,  on 
getting  the  loan  the  borrowing  merchant  would  not  wish 
to  take  out  notes  and  then  be  obliged  to  find  a  place  in 
which  to  deposit  them  again.  It  is  clear,  therefore,  that 
the  mere  power  to  issue  bank-notes  in  itself  is  not  the 
only  nor  the  most  important  way  of  meeting  an  emer- 
gency brought  on  by  a  disturbance  of  credit. 

It  is  a  crude  thought  that  an  increase  of  bank-notes  is 
needed  by  the  general  public  as  a  medium  of  exchange  on 
the  theory  that  business  men  are  unable  to  exchange  goods 
because  of  a  scarcity  of  currency.  The  real  difficulty  in 
a  time  of  stress  resides  not  with  the  general  public  and 
the  media  of  exchange — for  checks  are  as  good  as  ever  as 
a  medium  of  exchange  if  there  are  deposit-accounts  on 
which  they  can  be  drawn — but  with  the  banks,  with  the 
power  of  the  banks  to  expand  their  loans.  This  is  the 
pivotal  thing  in  any  plan  to  relieve  the  distress  of  a 
financial  panic  (in  spite  of  those  who  are  urging  an  elastic 
currency  as  a  cure-all). 

§  3.  So  much  for  the  relation  of  bank-issues  to  the 
situation  created  by  a  financial  crisis;  but  as  has  been 
already  pointed  out  there  are  other  elements  in  the  situa- 
tion of  far  greater  importance.  When  we  look  back  to 
the  panic  of  1907  we  find  three  important  happenings, 
connected  in  purpose  and  need,  which  altogether  tran- 
scend the  minor  question  of  the  issue  of  bank-notes,  or 
of  clearing-house-currency  for  public  use.  These  three 
points  of  central  importance  have  to  do  with  the  lend- 


132  BANKING  PROGRESS 

ing  power  of  the  banks  and  are  as  follows:  (1)  The  im- 
portation of  gold;  (2)  the  deposit  of  lawful  money  with 
the  banks  by  the  Treasury;  (3)  the  issue  of  clearing- 
house loan  certificates. 

Every  banker,  every  borrower,  who  was  concerned 
with  the  work  of  preventing  disaster  from  spreading  in 
1907  knows  how  dominating  were  these  three  matters. 
Why.^*  Because  they  directly  touched  the  power  of  the 
banks  to  lend.  There  was  a  crisis,  not  because  of  a  scar- 
city of  a  medium  of  exchange  in  the  hands  of  the  public, 
but  because  the  city  banks  had  had  excessive  demands 
made  upon  them  for  loans  and  because  they  held  some 
paper  which  had  become  more  or  less  unsound.  A  crisis 
comes  because  credit  has  been  unduly  expanded  in  a 
period  of  prolonged  prosperity;  because  in  an  optimistic 
spirit  men  have  entered  into  transactions  beyond  their 
actual  means,  as  is  shown  when  the  test  of  actual  pay- 
ment is  exacted;  and  in  a  time  of  fright  collateral  as  well 
as  goods  fall  in  price.  In  such  a  situation  liquidation 
needs  time  if  disaster  is  to  be  prevented.  The  banks 
are  even  called  upon  to  carry  houses  who  have  been  doing 
a  legitimate  business  but  who  are  now  in  trouble.  Just 
when  timid  persons  or  country  banks  are  drawing  down 
cash  reserves,  the  banks  are  forced  by  the  situation  to 
increase  their  loans.  In  the  one  week  ending  November 
2,  1907,  the  reserves  of  the  New  York  banks  fell  $37,000,- 
000,  while  loans  were  increased  $60,000,000.  Such  action 
showed  that  the  New  York  banks  met  a  diflScult  situa- 
tion with  courage  and  good  judgment.  At  their  own  risk 
they  came  to  the  rescue  of  a  hard-pressed  business  public. 
Everything  centred  in  those  things  which  would  aid  the 
lending  power  of  the  banks.  It  is  needless  to  say  that 
the  issue  by  the  bank  of  its  own  liabilities  in  the  form 
of  notes  would  have  been  an  insignificant  palliative  and 


BANK-NOTES  AND  LENDING  POWER    133 

would  not  have  touched  (except  as  before  mentioned)  the 
cash  reserves  and  the  power  to  lend.  The  one  central 
thing  to  he  done  at  the  moment  was  to  increase  reserves. 
Here  is  the  crux  of  the  whole  matter,  whether  it  is  a 
time  of  an  impending  stringency  or  the  storm-centre  of 
a  crushing  panic.  The  bank's  own  notes  (its  own  ha- 
bility)  cannot  legally  or  morally  be  used  to  fill  up  its 
reserves  (the  bank's  active  asset).  Here  is  the  fatal  de- 
ficiency of  bank-note  issues  as  a  means  of  curing  a  panic. 
The  one  thing  needed  was  lawful  money  which  could  be 
used  as  reserves.  We  must  face  facts  and  not  be  led 
away  by  theories.  The  New  York  banks  got  this  lawful 
money  in  two  ways:  (1)  by  importing  gold  and  (2)  by 
deposits  from  the  Treasury. 

They  imported  gold  as  a  means  of  enabling  them  to 
aid  needy  borrowers.  They  used  their  resources  to  buy 
or  borrow  over  $100,000,000  of  gold  because  it  was  one 
of  the  forms  of  lawful  money  by  which  reserves  could  be 
filled  up.  By  any  one  who  had  the  means  of  purchase, 
gold  could  be  got  in  a  week  from  Europe.  Therefore, 
gold  proved  to  be  the  one  part  of  our  monetary  system 
— ^besides  checks  on  deposits — which  was  perfectly  elastic. 
It  could  be  increased  by  importation  or  decreased  by  ex- 
portation at  will. 

Gold,  however,  was  not  the  only  form  of  lawful  money. 
When  banks  were  being  drained  of  their  reserves,  the  main 
recourse  was  to  the  Treasury  of  the  United  States.  (2) 
Unlike  bank-notes,  government  deposits  of  lawful  money 
directly  increased  the  reserves  and  increased  the  lending 
power  of  the  banks  from  four  to  six  times  the  deposits. 
The  secretary,  in  leaving  the  largest  sums  in  banks  in 
New  York,  the  centre  of  the  disturbance,  gave  his  aid 
where  it  would  do  the  most  good.  It  is  obvious  that  the 
service  rendered  by   the  importation   of  gold  and  the 


134  BANKING  PROGRESS 

deposits  of  lawful  money  by  the  Treasury  could  not  have 
been  accomplished  by  issues  of  bank-notes. 

The  most  important  of  the  devices  resorted  to  in  1907, 
however,  as  well  as  in  former  panics  as  far  back  as  1861, 
was  the  issue  of  clearing-house  loan  certificates.  (3)  WTiat 
was  the  point  of  their  issue.'*  It  was  not  that  the  coun- 
try needed  more  money  for  general  circulation  or  more 
media  of  exchange,  but  that  the  banks  whose  reserves 
had  declined  needed  aid  for  the  purpose  of  lending  to 
hard-pressed  borrowers.  In  a  crisis  what  is  wanted — 
and  wanted  above  all  other  things — is  the  loan.  Once 
given  the  loan,  the  borrower  has  no  diflficulty  in  finding 
a  medium  of  exchange,  by  which  he  can  transfer  his 
credit  in  a  way  to  meet  his  maturing  obligation.  The 
loan  is  the  primary  thing.  All  that  the  creditor  demands 
is  a  means  of  payment  acceptable  in  his  community.  It 
is  just  at  this  point  that  I  venture  to  say  we  find  the  most 
confusion  of  thinking  and  the  greatest  amount  of  loose 
talking.  It  is  carelessly  assumed  that  the  great  need 
is  an  issue  of  bank-notes,  when  in  reality  the  great  need 
is  some  means — whatever  it  may  be — which  will  enable 
a  bank  to  make  loans  to  a  client,  who  can  thereby  be 
saved  from  failure  and  from  hasty  and  ruinous  liquida- 
tion. The  whole  object  of  clearing-house  loan  certificates, 
then,  is — not  to  provide  currency — but  to  make  loans 
possible  to  legitimate  though  needy  borrowers.  After 
loans  are  made,  checks  provide  all  the  means  of  payment 
any  one  needs.  The  increase  of  a  bank's  liabilities  does 
not  increase  its  reserves  or  its  power  to  lend;  so  that  the 
issue  of  bank-notes — except  as  above  indicated — is  wholly 
aside  from  the  point. 

§  4.  One  result  of  the  publications  of  the  National 
Monetary  Commission  is  that  we  ought  to  know  much 


BANK-NOTES  AND  LENDING  POWER    135 

more  than  before  about  the  experience  of  the  great  banks 
in  Europe.^  But  deductions  from  Europe,  as  has  been 
pointed  out  by  the  chairman  of  the  commission,  must 
be  made  with  caution.  In  England  conditions  as  to 
payments  by  deposit-currency  are  much  like  our  own; 
but  in  France  very  little  work  is  done  by  checks  drawn 
on  deposits  and  nearly  all  by  the  notes  of  the  Bank  of 
France;  and  much  the  same  is  true  of  Germany.  Thus 
while  the  general  principles  of  banking  would  work  out 
similarly  in  England,  France,  Germany,  and  the  United 
States,  the  instruments  through  which  they  operate 
would  be  very  different. 

In  England,  in  a  crisis,  aid  seems  on  the  face  of  things 
to  have  been  rendered  by  an  increase  of  the  Bank  of 
England  notes,  when  the  Bank  Act  of  1844  was  sus- 
pended. In  fact,  as  every  one  knows,  the  act  previous 
to  1914  had  not  been  suspended  since  1866;  and  even 
when  suspended,  very  little  use  of  the  new  notes  was 
made.  Why?  Although  under  the  same  management, 
the  issue  department  is  as  much  separated  from  the 
banking  department  as  if  they  were  different  institutions. 
The  gold  and  securities  behind  the  notes  in  the  issue 
department  are  entirely  separated  from  the  resources  of 
the  banking  department.  Therefore,  the  latter  can  use 
the  notes  of  the  issue  department  in  its  reserves.  The 
whole  point  of  the  suspension  of  the  Bank  Act  lies,  then, 
in  the  fact  that  the  banking  department  can  fill  up  its 
reserves  by  taking  securities  to  the  issue  department  and 
getting  notes  for  them  under  a  temporary  suspension  of 
the  law.    The  immediate  object  is  to  increase  banking 

*  In  all  there  are  no  less  than  ten  volumes  on  European  banks  issued  by  the 
National  Monetary  Commission,  amounting  to  4,096  octavo  pages  (of  which 
that  on  the  German  Bank  Inquiry  of  1908  alone  contains  1,162  pages),  to  say 
nothing  of  other  subjects  treated.  For  students  these  works  are  highly  useful 
and  convenient. 


136  BANKING  PROGRESS 

reserves  so  that  loans  can  be  made  freely;  while  the  idea 
of  getting  out  more  notes  into  general  circulation,  on  any 
theory  that  the  public  needs  more  money,  is  not  at  all 
considered.  The  mere  possibility  of  a  resort  to  suspen- 
sion is  sufficient  to  quiet  alarm  because  legitimate  bor- 
rowers know  they  can  get  loans  whenever  required,  and 
therefore  practically  little  or  no  use  is  ever  made  of  the 
new  notes.  Of  late  years  the  change  in  the  rate  of  dis- 
count has  been  sufficient  to  prevent  reserves  from  falling 
to  a  point  where  suspension  was  ever  necessary.  Here 
again  in  an  emergency  it  is  a  question  of  the  lending 
power  of  the  bank  and  not  the  need  by  the  public  for 
more  bank-notes  as  a  medium  of  exchange. 

In  France  things  are  otherwise.  An  increase  of  loans 
by  th^  Bank  of  France  is  necessarily  carried  through  by 
an  issue  of  more  notes.  Within  the  outside  limit  set  by 
law  the  bank  can  increase  its  issues  at  will.  The  essen- 
tial thing,  of  course,  is  the  ability  to  get  a  loan  in  an 
emergency;  and  when  that  is  obtained,  as  a  matter  of 
course  the  bank  supplies  the  special  form  of  liability 
which  the  business  public  demands — which  in  France  is 
not  a  deposit-account  but  a  note-issue.  Either  would 
serve  the  same  purpose  as  a  means  of  payment;  but  that 
one  is  taken  which  custom  prescribes — the  check  in  Eng- 
land, the  note  in  France.  The  fundamental  thing  is  to 
be  found  in  the  power  to  lend  and  not  in  the  note-issues. 
And  back  of  that,  it  is  the  phenomenally  high  character 
of  the  short-time  paper  which  allows  the  Bank  of  France 
quickly  to  adjust  itself  to  changed  conditions,  together 
with  the  policy  of  keeping  very  high  metallic  reserves 
behind  the  notes — perhaps  85  per  cent  in  normal  times. 
They  have  escaped  panics  in  France  by  greater  care  than 
is  given  here  in  selecting  only  high-class  paper  at  the 
central  bank.     Copper  speculation,  however,  can  bring 


BANK-NOTES  AND  LENDING  POWER    137 

disaster  to  a  bank  there  as  well  as  here.  In  general,  the 
Bank  o!  France  has  been  able  to  maintain  a  low  and  uni- 
form rate  of  discount  chiefly  because  it  is  not  a  money- 
making  machine  and  is  excessively  conservative  in  the 
kind  of  paper  it  discounts. 

§  5.  Working  directly  from  the  facts  of  our  own  ex- 
perience and  from  a  reading  of  the  volumes  of  the  National 
Monetary  Commission,  we  may  be  permitted  a  very 
brief  statement  of  the  constructive  measures  which  should 
be  undertaken  to  prevent  the  excessive  and  ruinous  re- 
sults of  credit  expansions  in  the  future. 

First  of  all,  emphasis  must  be  placed  on  the  indisputa- 
ble truth  that  no  monetary  legislation  can  prevent  busi- 
ness optimism,  overtrading,  and  the  recurrent  waves  of 
speculation  and  liquidation.  The  control  of  such  move- 
ments, which  are  sure  to  be  pressed  upon  banks  by  an 
eager,  money-making  public,  lies  primarily  in  the  hands 
of  the  banks.  The  banks  are  the  servants  of  their  con- 
stituencies; as  a  rule,  they  do  not  lead,  but  are  apt  to 
follow  the  demand  of  their  customers;  but  they  must 
not  be  willing  to  follow  recklessly.  Not  infrequently  we 
hear  it  said  that  European  countries,  with  large  central 
banks,  have  a  system  which  prevents  panics.  The  truth 
is  that  panics  have  been  largely  avoided  in  the  last  decades 
in  such  countries  as  England,  France,  and  Germany  be- 
cause the  management  has  been  cautious  and  conserva- 
tive in  granting  loans.  Quite  irrespective  of  the  differ- 
ences between  the  forms  of  banking  organization  in  the 
United  States  and  the  forms  employed  in  England, 
France,  and  Germany,  we  could  as  effectively  suppress 
potential  panics  as  they  if  we  were  as  willing  as  they  to 
scrutinize  loans. 

In  the  second  place,  we  must  in  no  way  relax  our  efforts 


138  BANKING  PROGRESS 

to  satisfy  the  great  need  of  an  elastic  bank  circulation. 
We  need  what  might  be  called  marginal  elasticity — a 
change  of  relatively  small  amounts  on  the  margins  of  a 
fairly  large  normal  circulation,  dependent  for  its  amount 
wholly  on  the  demands  of  trade  and  not  on  the  fiscal 
needs  of  the  government.  The  various  bills  presented  to 
Congress — chief  among  which  was  the  bill  of  the  American 
Bankers'  Association^ — bear  on  this  general  point.  They 
were  important;  but  as  previously  explained  they  did  not 
provide  a  remedy  for  the  situation  existing  in  a  time  of 
panic.  Expansion  of  credit  can  go  on,  and  has  gone  on, 
through  the  banking  department  of  the  Bank  of  England 
without  the  issue  of  any  notes  and  solely  through  the 
creation  of  deposit-accounts  as  the  consequence  of  ex- 
panded loans.  Therefore,  we  must  admit  the  fact  that 
an  elastic  bank-note  circulation,  while  bringing  needed 
reforms,  will  not  accomplish  in  times  of  stress  what  most 
persons  have  in  mind  when  urging  a  change  in  our 
monetary  system. 

Having  now  disclosed  the  real  need,  how  can  that  need 
be  met  effectively?  In  the  main,  assistance  must  come 
in  such  a  way  that  reserves  can  be  enlarged  with  safety. 
Therefore,  the  emergency  issues — if  any  are  allowed — 
must  be  in  some  form  of  lawful  money.  How  and  by 
whom  are  they  to  be  issued  ? 

Certainly  not  by  the  government.  The  very  first  les- 
son of  public  finance  is  to  learn  to  separate  the  fiscal  from 
the  monetary  functions  of  the  Treasury.  The  State  must 
separate  its  income  and  expenditures,  its  borrowings  and 
payments,  its  fiscal  duties,  wholly  and  radically  from  its 
control  over  the  monetary  standard  and  the  media  of 
exchange.  To  confuse  or  to  mix  these  is  to  invite  dis- 
aster at  the  first  real  crisis.     Compare  the  chaos  into 

'  See  Appendix  I. 


BANK-NOTES  AND  LENDING  POWER    139 

which  we  fell  when  we  confused  these  two  things  on  and 
after  February,  1862  (on  making  the  first  issue  of  green- 
backs as  a  loan),  with  the  stability  of  the  French  standard 
during  the  enormous  expansion  of  loans  in  their  crisis 
of  1870-1873. 

In  brief,  what  is  the  essence  of  the  remedy  ?  Clearly 
enough,  the  lending  power  of  a  bank  cannot  be  increased 
in  an  emergency  by  means  of  an  increase  in  liabilities. 
It  can  come  only  by  an  operation  dealing  with  its  assets 
and  in  such  a  way  that  a  part  of  the  assets — either  bank- 
able short-time  paper  or  securities — can  be  transformed 
into  means  of  payment  which  will  enlarge  the  reserves. 
The  whole  emphasis  should  be  put  upon  the  matter  of 
lending  power.  In  the  past  this  end  has,  in  fact,  been 
accomplished  either  by  using  securities  to  import  gold, 
or  to  obtain  government  deposits,  or  by  getting  clearing- 
house certificates  to  the  amount  of  75  per  cent  of  the 
value  of  chosen  commercial  assets.  Such  methods  are 
irregular,  voluntary,  and  clumsy.  The  underlying  prin- 
ciples, however,  should  be  incorporated  into  practicable, 
simple,  legal  means  open  to  all,  and  well  understood  be- 
fore any  emergency  arises. 

The  issue  of  clearing-house  loan  certificates  has  been, 
in  my  judgment,  a  means  of  averting  untold  disaster  in 
many  crises;  the  collateral  behind  them  has  been  based 
on  the  fundamental  business  of  the  country,  and  they 
have  always  been  retired  at  an  early  date  without  the  loss 
of  a  dollar.  Yet  it  is  clear  that  as  a  practical  device 
they  are  somewhat  clumsy  and  possibly  exposed  to  the 
10  per  cent  tax  on  State-bank  issues.  They  may  be, 
however,  only  the  first  step  in  an  evolution  to  something 
even  more  effective  but  built  up  on  the  same  lines.  It  is 
always  wise  to  allow  the  remedy  to  grow  out  of  our  past 
experience  rather   than   to   introduce   an   entirely   new 


140  BANKING  PROGRESS 

scheme  to  which  it  may  take  a  long  time  to  get  ad- 
justed. 

Therefore,  the  central  point  of  our  banking  reform, 
so  far  as  I  am  able  to  suggest  anything  practical,  is  an 
organization  of  national  banks,  supervised  by  the  gov- 
ernment but  not  under  government  management,  which 
shall  have  the  power,  under  regulations  securing  great 
care  in  the  selection  of  collateral,  to  transform  picked 
assets  and  securities  into  a  means  of  payment  which  can 
be  used  to  increase  reserves.  If  notes  are  also  issued 
there  should  be  proper  elasticity.  Such  a  method,  after 
all,  is  essentially  the  same  as  that  used  in  a  crisis  at  the 
Bank  of  England — the  country  whose  conditions  are 
most  nearly  like  our  own.  If  we  accept  these  principles 
and  the  general  purpose,  it  would  not  be  difficult  to  draft 
the  law  which  should  contain  them. 

We  ought  not  to  be  wedded  to  names  or  preconceptions. 
It  is  immaterial  whether  such  an  organization  is  called  a 
central  bank  or  not.  It  is  material,  how^ever,  that  it 
should  accomplish  the  purpose  of  enabling  any  individual 
bank  to  meet  a  temporary  parox;y'sm  of  credit  by  getting 
more  reserves  and  by  increasing  its  lending  power  through 
the  deposit  of  first-class  collateral.  My  instinct  is  against 
any  one  large,  centralized  institution  the  management 
of  which  might  become  an  object  of  attack  or  a  pohtical 
prize  in  a  campaign.  So  far  as  I  can  now  see,  it  ought 
to  be  built  up  out  of  the  present  clearing-house  organiza- 
tions. There  should  be  common  action  and  conference 
of  those  who  know  the  conditions  of  business  in  all  parts 
of  the  country;  but  the  actual  judgment,  when  the  qual- 
ity of  the  paper  and  securities  offered  by  a  bank  in  order 
to  obtain  those  means  of  payment  is  to  be  passed  upon, 
should  obviously  be  given  only  by  those  in  certain  parts 
of  the  country  who  are  familiar  with  persons  and  trade 


BANK-NOTES  AND  LENDING  POWER    141 

in  the  localities  where  the  requests  are  made.  More- 
over, the  relation  of  State  banks  and  trust  companies 
to  the  national  banks  in  the  large  cities  in  a  time  of  crisis 
can  be  best  regulated  through  organizations  like  the 
clearing-house  boards.  There  should  be  no  difficulty 
whatever  in  creating  local  or  district  clearing-house 
boards,^  chosen  by  the  banlcs  themselves — just  as  clear- 
ing-house committees  are  now  chosen — who  should  pass 
upon  the  issues  of  those  Reserve  notes.  These  district 
boards  might  then  be  united  or  represented  for  common 
action  in  a  central  board,^  who  might  have  a  veto  upon 
the  extreme  action  or  the  possible  unwisdom  of  any  one 
local  board.  The  scheme  has,  moreover,  the  political 
advantage  that  it  does  not  propose  a  money-making  in- 
stitution nor  a  financial  "octopus,"  but  a  simple,  direct 
method  of  enabling  the  borrowing  public  to  get  aid  from 
banks  in  time  of  distress. 

Were  such  an  organization  once  put  into  operation  I 
am  firmly  convinced  that  we  should  henceforth  be  pre- 
served from  the  highly  terrifying  and  unnecessary  parox- 
ysms of  credit  which  have  characterized  our  past  financial 
history.  More  than  that,  we  should  then  come  to  under- 
stand by  actual  experience — just  as  in  England  since 
1844 — that  our  expansions  of  credit  and  its  liquidation 
may  come  and  go  independently  of  the  quantity  of  bank- 
notes outstanding.  Attention  will  then  be  taken  away 
from  the  minor  question  of  the  quantity  of  notes  in  the 
hands  of  the  public  to  the  vital  question  of  the  character 
of  the  credit  granted  and  to  the  control  and  vigilance 
over  the  kinds  of  discounts  made  by  a  bank.  From  what- 
ever angle  we  approach  the  banking  business  we  are 

^  This  suggestion,  put  out  in  1910,  was  the  essence  of  what  became  Federal 
Reserve  Banks  in  the  twelve  districts. 
^  Later  the  Federal  Reserve  Board  carried  out  this  function. 


142  BANKING  PROGRESS 

always  forced,  sooner  or  later,  to  recognise  that  every- 
thing depends  upon  the  quality  of  the  discounts  and  the 
kind  of  assets  held  as  a  consequence  of  making  loans. 
Tlic  measures  recently  put  into  force  by  the  comptroller 
of  the  currency,  such  as  more  stringent  examinations, 
are  to  be  highly  praised  because  they  bear  directly  upon 
this  general  principle.  It  lies  at  the  centre  of  all  real 
insurance  or  protection  to  depositors;  and  it  lies  at  the 
centre  of  our  whole  question  of  banking  reform  which 
aims  to  relieve  us  of  the  disasters  of  sudden  and  forced 
liquidation  in  a  time  of  panic. 


CHAPTER  VIII 
POLITICAL  HISTORY  OF  THE  FEDERAL  RESERVE  ACT 

§  1.  The  Aldrich-Vreeland  Act  of  1908,^  passed  largely 
for  political  effect  and  expiring  June  30,  1914  (later  ex- 
tended to  June  30,  1915),  was  the  cover  under  which 
preparations  were  made  for  a  thorough  revision  of  our 
currency  system.  That  act  was  negative  in  its  working, 
and  before  the  European  War  no  resort  was  ever  made 
to  its  provisions  for  issuing  emergency  notes  through  cur- 
rency associations.  In  the  autumn  of  1912  and  1913 
the  tension  of  credit  was  probably  as  extreme  as  in  1907, 
but,  as  was  to  have  been  expected,  no  use  was  made  of 
the  act.^  The  essential  theory  of  it  was  the  obvious 
dependence  on  an  issue  of  bank-notes  as  the  remedy 
for  a  stringency;  while,  in  truth,  the  difficulty  lay  in 
the  shortcomings  of  our  credit  organization.  Deeper 
than  the  inelasticity  of  the  bank-issues  lay  the  inelas- 
ticity of  credit  and  of  the  power  to  lend.  It  is  interest- 
ing, therefore,  to  watch  the  development  of  reform  pro- 
posals and  to  see  how  far  they  showed  an  understanding 
of  the  real  weaknesses  of  our  banking  and  monetary 
system. 

The  formation  of  currency  associations  under  the  act 
of  1908  had  been  urged  by  Secretary  MacVeagh^  on  the 
various    clearing-house    centres;     but   although    formed 

*  For  a  full  study  of  this  law,  see  Chapter  IV. 

'  A  considerable  issue  of  Aldrich-Vreeland  notes  was  made  in  the  crisis  of 
1914,  after  the  act  had  been  amended  by  the  Federal  Reserve  Act  of  1913, 
and  also  by  legislation  in  August,  1914.  C/.  Laughlin,  Credit  of  the  Nations, 
pp.  299-305. 

s  la  1910,    See  Fin.  Report,  1910,  p.  5. 

143 


144  BANKING  PROGRESS 

they  were  organized  with  much  scepticism  as  to  their 
actual  use.  The  tax  on  the  notes  was  unintelhgently 
heavy,  making  their  use  almost  prohibitory.  On  the 
other  hand,  if  resort  had  been  made  to  these  notes  rather 
than  to  clearing-house  certificates,  they  would  have  had 
the  advantage  of  a  circulation  wider  than  the  narrow 
field  of  the  certificates.  Since  they  could  not,  however, 
be  used  as  lawful  reserves  by  national  banks,  they  would 
not,  in  fact,  have  touched  the  lending  power  of  these 
banks  as  directly  as  did  clearing-house  certificates.  If 
A  could  not  get  a  loan  or  extension  at  Bank  X,  and  trans- 
ferred his  account  to  Bank  Y  on  the  promise  of  notes  to 
be  obtained  through  a  currency  association,  A  might 
have  used  these  notes  to  take  up  his  obligation  held  by 
Bank  X;  the  next  day  Bank  X  could  have  presented 
these  notes  to  Bank  Y  as  a  demand  obligation  against 
cash  reserves;  thus  they  would  not  have  been  so  useful 
as  clearing-house  certificates  which  could  have  been  used 
in  settling  balances  between  banks.  Yet,  apart  from  the 
tax,  some  bankers  believed  that  these  notes  would  have 
been  effective  in  time  of  stress.  Certainly,  by  being  paid 
out  to  the  pubhc,  they  might  have  prevented,  to  some 
extent,  the  drawing-down  of  banking  reserves  of  lawful 
money.  At  the  best  they  could  have  been  only  a  pallia- 
tive. Yet  it  should  be  noted  that  these  notes,  whatever 
their  efficiency,  broke  with  the  past  unmistakably  by 
being  obtainable  on  the  pledge  of  other  security  than 
United  States  bonds. 

The  provision  in  the  act  creating  a  National  Monetary 
Commission  had  important  consequences.  Its  composi- 
tion, however,  was  tj'pical  of  our  methods:  the  eighteen 
members  were  chosen  equally  from  the  two  Houses  of 
Congress,  and  practically  none  of  them  were  experts.^ 

*  It  was  at  first  proposed  to  have  six  members  outside  of  Congress.     Cf.  p.  61. 


POLITICAL  HISTORY  OF  ACT  145 

Consequently,  the  education  of  the  commission  itself 
was  the  first  duty,  and  a  considerable  number  of  treatises 
were  prepared  at  the  behest  of  the  commission  on  topics 
more  or  less  pertinent  to  the  subject.  The  formation  of 
a  concrete  plan  of  reform,  however,  came  through  the 
visits  of  the  chairman  and  others  to  Europe  and  through 
some  other  influences  at  home.  It  is  to  the  credit  of  the 
chairman,  Senator  Aldrich,  that,  in  comparison  with  his 
attitude  in  1908,^  he  performed  a  complete  volte  face. 
European  experience,  well  known  already  to  American 
students  of  this  subject,  was  now  driven  home  on  those 
who  might  influence  the  action  of  Congress.  But  the 
definite  outlines  of  the  plan  of  the  commission  presented 
January  17,  1911,  must  have  been  due  to  the  suggestions 
of  a  few  experienced  persons  in  this  country,  who  were 
consulted  by  the  chairman  near  the  end  of  1910. ^  What- 
ever its  origin,  the  plan  actually  laid  before  the  country 
by  the  commission  had  the  distinction  of  attacking  the 
pivotal  weakness  of  our  system — the  organization  of 
credit.  That  was  an  epoch-making  advance.  Into  the 
personal  and  political  animosities  connected  with  the  chair- 
man of  the  commission  it  is  needless  to  enter  here;  but  in 
getting  legislation  it  is  obvious  that  political  prejudices 
are  facts  as  much  as  stone  walls,  and  they  had  their  due 
influence  on  the  result. 

§  2.  In  fact,  political  considerations  were  ruling  in 
regard  to  a  subject  which  of  all  others  ought  to  have  had 
non-partisan  treatment.  During  the  campaign  of  1912 
every  effort  was  made  to  keep  the  currency  question  out 
of  politics.     The  fact,  however,  that  the  plan  of  the  com- 

1  Cf.  supra,  pp.  54,  68. 

^  Besides  Mr.  Aldrich  those  most  concerned  in  its  making  were,  by  common 
report,  Messrs.  Paul  Warburg,  F.  A.  Vanderlip,  A.  Piatt  Andrew,  and  others. 


146  BANKING  PROGRESS 

mission  was  intimately  associated  with  the  name  of  Sen- 
ator Aldrich,  the  head  of  the  Protectionist  RepubHcans, 
was  present  in  every  one's  mind.  This  fact  forced  the 
question  into  poHtics.  The  commission,  from  the  Re- 
publican point  of  view,  made  the  fatal  mistake  of  delay- 
ing the  presentation  of  its  report  for  four  years  until  the 
Lower  House  became  Democratic.  The  reaction  in  favor 
of  the  Democratic  party  made  it  patent  that  no  bill  un- 
satisfactory to  the  Democrats  could  become  a  law.  But 
the  demand  for  non-partisan  action  was  still  so  great  that 
even  Democratic  leaders  believed  that,  while  the  matter 
could  not  be  brought  up  in  the  winter  session  of  1911- 
1912,  just  before  a  presidential  campaign,  it  ought  to  be 
taken  up  in  the  short  winter  session  of  1912-1913  after  the 
election.  Political  events,  however,  swept  these  hopes 
aside. 

The  Democratic  convention  at  Baltimore  saw  a  strug- 
gle between  the  conservative  and  radical  elements  of 
the  party  in  which,  in  a  sense,  the  latter  won.  Although 
Mr.  Bryan  could  not  control  the  result,  neither  could  the 
conservatives.  The  nomination  of  Woodrow  Wilson, 
who  was  not  Mr.  Bryan's  candidate,  created  a  situation 
that  made  it  seem  necessary  to  placate  Mr.  Bryan  by 
allowing  him  to  write  the  platform;  and  the  currency 
plank  arrayed  the  party  against  "the  so-called  Aldrich 
bill  or  the  establishment  of  a  central  bank."  ^  The 
danger  of  making  the  subject  a  party  issue  was  diminished, 
however,  by  the  RepubHcan  platform,  which  declared 
only  in  favor  of  general  principles  and  not  for  any  specific 
plan.  Consequently,  the  currency  issue  was  little  heard 
of  during  the  campaign  of  1912.     The  eccentric  declara- 

^  It  has  been  claimed  that  the  true  draft  was  altered  by  the  omission  of  the 
letter  "f,"  and  should  have  read  "Aldrich  bill  for  the  establishment  of  a  cen- 
tral bank." 


POLITICAL  HISTORY  OF  ACT  147 

tion  of  the  Progressive  platform  drew  no  discussion. 
Very  early  in  the  campaign  it  became  evident  that  Mr. 
Wilson  would  be  elected.  The  election  of  a  Democratic 
Senate  later  gave  his  party  full  control  of  legislation. 
Hence,  Democratic  leaders  had  no  disposition  to  allow  a 
currency  act  to  pass  in  the  short  winter  session,  when 
they  could  very  soon  stamp  their  own  impress  on  the 
most  important  problem  up  for  solution  since  the  Civil 
War — least  of  all  a  measure  regarded  as  the  handiwork 
of  Senator  Aldrich,  a  Republican  leader. 

While  Mr.  Wilson  spoke  of  giving  the  question  non- 
partisan treatment,  he  had  elements  in  his  party  diflScult 
to  be  unified  on  common  ground.^  As  early  as  September, 
1912,  it  was  known  that  the  Pujo  subcommittee  of  the 
House,  dominated  by  its  counsel,  Mr.  Samuel  Unter- 
myer,  intended  to  report  specific  monetary  legislation  in 
connection  with  the  investigation  of  the  "Money  Trust.'* 
This  policy  infringed  on  the  legislative  work  of  the  Glass 
subcommittee.  The  conflict  finally  ended  in  the  triumph 
of  Mr.  Glass  (who  in  the  extra  session  of  the  new  Con- 
gress, April,  1913,  became  chairman  of  the  full  Banking 
and  Currency  Committee).  In  the  meantime,  by  the 
summer  of  1912,  the  so-called  Aldrich  Plan  (reported  in 
January,  1911,  to  both  House  and  Senate)  seemed  to 
have  become  politically  dead.  In  November,  1912,  the 
Glass  subcommittee  was  spurred  into  activity  by  the  work 

*  The  radicals  in  the  House,  like  R.  L.  Henry  of  Texas,  wished  extreme  action 
in  connection  with  the  investigation  of  the  "Money  Trust,"  hoping  to  get 
useful  campaign  material.  The  resolution  demanding  this  investigation  was 
finally  sent  to  the  Banking  and  Currency  Committee,  where  it  was  given  to 
one-half  of  the  committee  presided  over  by  Mr.  Pujo,  then  the  chairman  of  the 
whole  committee;  while  the  other  half  of  the  committee,  to  be  presided  over 
by  Mr.  Carter  Glass,  next  in  rank  to  Mr.  Pujo,  was  intrusted  with  the  definite 
task  of  preparing  legislation  on  banking  and  currency.  To  Mr.  Glass's  sub- 
committee the  plan  of  the  Monetary  Commissiou  and  other  bills  were  also 
referred. 


148  BANKING  PROGRESS 

of  the  Pujo  subcommittee.  Up  to  that  time,  tentative 
Democratic  banking  bills  did  not  go  far,  even  proposing 
to  leave  untouched  the  existing  inelastic  national  bank- 
notes secured  by  bonds.  In  fact,  having  seen  divisions 
in  the  party  because  of  silver  and  other  monetary  issues 
in  the  past,  Democratic  leaders  were  loath  to  take  the 
chance  of  arousing  discussion  on  these  questions.  Poli- 
ticians hoped  to  dodge  serious  legislation  by  postponing  it. 
Meanwhile  public  opinion,  developed  in  a  systematic 
way,  had  become  intelligent  and  insistent  in  favor  of 
thorough  and  constructive  legislation.  Foreseeing  that 
this  could  come  only  through  the  Democratic  party,  the 
South  was  made  the  objective  of  an  active  propaganda 
in  favor  of  banking  reform.^  So  vigorous  and  successful 
was  this  work  that,  later,  a  Democratic  Congress  found 
many  of  its  constituencies  demanding  legislation  of  a 
sound,  specific  character.  In  the  Sixty-second  Congress, 
in  the  Democratic  House,  the  radicals  were  outnumbered 
2  to  1;  and  in  the  Sixty -third  Congress  the  ratio  was 
probably  about  the  same.  A  Democratic  Congress, 
therefore,  called  in  extra  session  as  early  as  November, 
1912,  by  President-elect  Wilson,  had  to  face  the  problem 

1  The  National  Citizens'  League  for  the  Promotion  of  a  Sound  Banking  Sys- 
tem, with  headquarters  in  Chicago,  began  a  campaign  of  education  through- 
out the  coimtry  in  June,  1910,  giving  main  attention  to  the  South,  and  to 
Progressive  States  in  the  West  and  Northwest.  Effective  organizations  were 
established  in  forty -five  States,  chiefly  among  business  men.  Contributions 
were  solicited  from  banks  on  the  ground  that  they  represented  also  the  bor- 
rowing business  public,  who  were  mainly  interested  in  the  reform.  A  vast 
amount  of  material  was  printed  in  the  newspapers  and  pamphlets,  while  a 
volume  on  Banking  Reform  (1912,  23  chapters,  8vo,  pp.  xii  +  428)  was  pub- 
lished. For  the  man  in  the  street  simple  exposition  was  supplied  in  a  fort- 
nightly issue  and  in  newspapers;  but  the  volume  on  Banking  Reform  was  a 
text-book  for  use  by  editors,  speakers,  and  congressmen.  Speaking  was  had 
especially  in  the  South.  The  purpose  of  this  organized  and  systematic  work 
was  to  create  public  opinion  in  the  home  districts,  and  it  had  the  expected 
result  in  the  final  votes  in  Congress.  The  League  stopped  its  work  November 
1,  1913. 


POLITICAL  HISTORY  OF  ACT  149 

from  which  there  was  no  escape.  Then  Mr.  Wilson's 
firm,  guiding  hand  appeared.  He  was  evidently  advised 
of  the  progress  already  made  by  the  Glass  subcommittee, 
but  he  kept  his  own  counsel.  From  the  very  date  of  the 
calling  of  the  extra  session  in  November,  the  chances  of 
currency  reform  seemed  suddenly  to  become  favorable. 
To  Mr.  Wilson's  championship  more  than  to  any  other 
force  was  the  final  legislative  result  due.  It  came  to  be 
expected  that  a  banking  and  currency  bill  would,  if  pos- 
sible, be  taken  up  in  the  extra  session  (spring  of  1913); 
and  the  Glass  subcommittee  held  hearings  in  January, 
intending  to  have  a  bill  ready  by  the  time  the  extra  ses- 
sion convened.^ 

The  still  larger  political  significance  of  banking  and 
monetary  reform,  however,  cannot  be  disregarded.  It  is 
well  known  that  the  Democratic  party  had  in  past  years 
sympathized  with  the  pleas  for  unsound  paper  money, 
and  had  been  committed  to  the  free  coinage  of  silver. 
The  Republican  party,  it  is  true,  was  on  its  side  respon- 
sible for  the  silver  act  of  1890.  Fortunately,  during  the 
control  of  the  Democratic  party  by  President  Cleveland 
his  party  was,  with  remarkable  generalship,  manoeuvred 
into  a  position  of  soundness  on  the  silver  question.  When 
Mr.  Bryan  gained  control  and  enforced  on  his  party  his 

^  The  Glass  subcommittee  was  at  work  on  the  bill  early  in  December,  1912; 
hearings  were  held  in  January,  1913;  and  the  bill  was  practically  outlined  be- 
fore the  inauguration,  and  approved  by  President  Wilson.  In  the  extra  session 
of  the  spring  of  1913,  the  new  House  Gjmmittee  on  Banking  and  Currency 
had  been  named,  with  Mr.  Carter  Glass  as  chairman  of  the  whole,  only  a 
short  time  before  the  House  bill  was  introduced,  June  18,  1913.  The  committee 
began  work  on  the  bill  July  7;  it  was  reported  to  the  Democratic  caucus  early 
in  September,  ratified,  reported  to  the  House  September  9,  and  passed  by 
the  House  September  18.  In  the  Senate,  hearings  were  held  on  the  bill  until 
October  25;  it  was  considered  by  the  Banking  Committee,  of  which  Mr.  Owen 
was  the  chairman,  for  a  month;  reported  to  the  Senate  December  1;  debated 
until  December  19;  went  to  a  conference  committee,  whence  it  was  returned  De- 
cember 22;  was  passed  and  received  the  President's  signature  December  23, 1913. 


150  BANKING  PROGRESS 

views  in  favor  of  the  free  coinage  of  silver,  and  the  issue 
of  all  paper  money  by  the  government  (involving  the  sub- 
stitution of  government  paper  money  for  national  bank 
notes),  the  Democratic  party  was  successively  beaten  in 
every  campaign  which  pivoted  on  those  issues.  It  was 
not  the  strength  of  the  Republican  party,  but  the  aberra- 
tions of  the  Democratic  party  on  banking  and  currency, 
which  drove  a  majority  of  the  voters  to  elect  RepubUcan 
presidents.  In  view  of  the  disasters  which  had  come 
upon  Democrats  through  monetary  issues,  it  is  easy  to 
understand  the  reluctance  of  their  leaders  to  take  them 
up  just  when  party  success  in  the  national  elections  seemed 
possible.  Nevertheless,  the  development  of  industry  in 
the  South,  and  the  spread  of  a  business,  rather  than  a 
political,  point  of  view  on  currency  questions  throughout 
Democratic  States  brought  a  growing  belief  that  only 
by  passing  a  great  constructive  act  on  banking  and  cur- 
rency could  the  Democratic  party  wipe  out  the  distrust 
due  to  past  eccentricities  on  those  issues,  and  win  that 
confidence  from  the  business  element  which  was  essential 
to  remaining  in  political  power.  The  statesmanship  by 
which  President  Wilson,  with  the  aid  of  Democratic  lead- 
ers, put  their  party  behind  an  epoch-making,  construc- 
tive measure  and  passed  it  on  December  23,  191S,  is  a 
monumental  event  in  our  political  history.  It  assumes 
the  character  of  a  political  miracle.  No  little  credit  for 
the  political  result  also  should  be  assigned  to  Mr.  Bryan, 
who  brought  his  large  following  to  the  support  of  the 
measure.  Hereafter,  the  pohtical  lines  on  money  and 
banking  questions  must  be  drawn  in  entirely  new  ways; 
so  that  the  effects  of  this  act  on  both  our  business  and 
our  political  development  can  scarcely  be  exaggerated. 

§  3.    The  preliminary  draft  of  the  Federal  Reserve 
Act  was  formed  by  the  subcommittee  of  the  House  Bank- 


POLITICAL  HISTORY  OF  ACT  151 

ing  and  Currency  Committee,  under  the  chairmanship 
of  Mr.  Carter  Glass,  in  the  winter  of  1912-1913.  The  ex- 
pert of  this  committee  and  afterward  secretary  of  the 
Federal  Reserve  Board,  H.  Parker  Willis,  had  probably 
more  influence  than  any  other  man  in  shaping  the  measure 
in  its  formative  legislative  period.  Inasmuch  as  the  in- 
cubation of  banking  reform  had  been  going  on  through 
the  struggles  of  many  years,  the  final  result  could  not  be 
traced  to  any  one  source  or  to  any  one  man;  but  the 
main  principles  in  it  were  already  the  common  property 
of  trained  men  in  Europe  and  the  United  States.  The 
real  problem  of  statesmanship  was  in  creating  a  bill 
which  would  meet  the  varying  points  of  view  of  those  in 
power  and  yet  be  sound;  and  the  final  act  shows  in  many 
sections,  as  was  inevitable,  the  evidences  of  struggle  and 
compromise. 

Mr.  Willis,  who  was  intimately  acquainted  with  the 
events  going  on  in  the  winter  of  1912-1913,  and  in  the 
months  of  active  legislation  during  the  following  extra 
session,  says  of  the  origin  of  the  bill:^ 

It  is  not  drawn,  even  largely,  from  any  single  source,  but  is 
the  product  of  comparison,  selection,  and  refinement  upon  the 
various  materials,  ideas,  and  data  rendered  available  through- 
out a  long  course  of  study  and  agitation.  Many  bills  embody- 
ing the  same  general  line  of  thought  that  now  finds  expression 
in  the  new  act  have  been  offered  in  Congress;  some  have  been 
suggested  outside  that  body.  The  most  fundamental  concept 
of  all — that  of  uniting  the  banks  of  the  country  into  organized 
groups — is  found  in  the  clearing-house  organizations,^  which 
in  time  of  stress  have  pooled  their  resources  and  converted 
bank  assets  into  the  equivalent  of  reserve  money.  .  .  .  [The 
earliest  of  the  bills  found  useful]  was  the  bill  recommended  by 
the  Indianapolis  Monetary  Commission,  which  did  not  provide 
for  co-operative  unions  of  banks,  but  upon  which  the  framers 
of  the  present  act  have  evidently  drawn  for  some  of  their  ideas. 

1  American  Economic  Review,  March,  1914,  pp.  13  /.         ^  Cf.  supra,  p.  149. 


152  BANKING  PROGRESS 

As  to  the  indebtedness  of  the  new  act  to  the  bill  of  the 
National  Monetary  Commission,  Mr.  Willis  speaks  as 
follows : 

By  many  the  new  law  is  regarded  as  a  partial  copy  of,  or 
plagiarism  from,  the  Aldrich  Bill;  and  that  view  has  been 
widely  expressed  both  in  and  out  of  Congress.  That  such  was 
not  the  opinion  of  Mr.  Aldrich  himself,  his  scathing  and  bitter 
denunciation  of  the  House  bill  seems  to  bear  abundant  witness.^ 
.  .  .  The  Aldrich  Bill  may  be  considered  from  two  standpoints : 
(1)  that  of  its  theory  and  broad  general  plan  on  the  one  hand, 
and  (2)  that  of  its  machinery  and  technic  of  construction  on 
the  other.  From  the  first  standpoint  there  is  no  shadow  of 
relationship  or  similarity  between  the  Federal  Reserve  Act 
and  the  Aldrich  Bill.  .  .  .  The  Aldrich  Bill  provided  for  a 
single  central  "reserve  association"^  with  scanty  public  over- 
sight. .  .  .  The  new  act  .  .  .  leaves  banking  as  such  to  be 
practised  by  bankers;  it  vests  the  control  of  banking  in  the 
hands  of  government  officers.  The  theory  and  purpose  of  the 
new  act  are  widely  different  from  those  of  the  Aldrich  Bill.  .  .  . 

From  the  standpoint  of  technic  .  .  .  the  case  is  quite  differ- 
ent. With  regard  to  stock-issues,  kinds  of  paper  eligible  for 
rediscounts,  and  not  a  few  other  particulars,  the  Federal  Reserve 
Act  follows  lines  laid  down  in  the  measure  which  bore  the  name 
of  Senator  Aldrich,  In  fact,  the  original  House  bill,  for  stra- 
tegic purposes,  retained  wherever  it  could  safely  do  so,  the 
language  of  the  Aldrich  Bill  as  regards  banking  technic,  its 
framers  recognizing  that  by  so  doing  they  enormously  reduced 
the  hold  of  the  opposition.  .  .  .  Moreover,  the  most  desirable 
features  of  the  Aldrich  Bill  were  found  in  its  sections  dealing 
with  banking  technic — upon  which  some  of  the  country's  best 
banking  ability  had  been  expended.  .  .  . 

A  review  of  the  detailed  provisions  of  the  measure  shows, 
therefore,  that,  while  the  conception  of  banking  reform  upon 
which  it  is  founded  is  the  same  that  has  constituted  the  staple 

'  Proceedings  of  American  Academy  of  Political  and  Social  Science,  October, 
1913. 

'  It  was  generally  understood  that  the  elaborate  organization  of  the  reserve 
associations  and  the  system  of  control  was  the  main  personal  contribution  of 
Mr.  Aldrich  to  the  bill. 


POLITICAL  HISTORY  OF  ACT  153 

of  the  banking  reform  movement  of  recent  years  .  .  .  the  act 
as  a  whole  is  based  upon  a  conception  and  plan  entirely  its 
own,  applies  in  many  fundamental  respects  methods  of  con- 
trol and  administration  that  have  been  given  at  least  a  new 
form,  and  includes  several  important  innovations,  not  hereto- 
fore conspicuous  in  banking  discussion,  although  admittedly 
significant,  not  to  say  necessary,  to  any  thorough  reorganiza- 
tion upon  sound  principles. 

§  4.  In  order  to  aid  in  bringing  about  early  action 
by  Congress  the  author  drew  up  in  January,  1913,  a 
memorandum  of  the  political  situation,  which  was  sent 
to  the  President-elect.  Whatever  its  effect,  its  contents 
may  now  have  some  historical  value: 

The  Glass  subcommittee  on  currency  and  banking  has  un- 
doubtedly framed  a  bill  which  could  be  soon  given  out,  even 
though  no  action  could  be  expected  at  this  (winter)  session 
(1912-1913).  Public  opinion  throughout  the  country  is  more 
developed  in  favor  of  action  than  is  realized  in  Washington. 
It  would  be  an  error  of  political  strategy  to  delay  legislation 
beyond  the  spring  (extra)  session  (1913),  for  the  following 
reasons : 

1.  To  postpone  it  to  the  long  session  of  1913-1914  would  bring 
congressmen  face  to  face  with  a  new  election  in  the  summer 
and  autumn  of  1914.  If  there  is  any  hesitation  now  to  treat 
the  money  question,  it  will  be  much  stronger  next  year.  That 
will  probably  mean  another  postponement. 

2.  There  have  been  certain  psychological  times  when  mon- 
etarj^  legislation  was  possible:  (1)  After  the  agitation  by  busi- 
ness men  in  1898  (following  the  silver  campaigns)  legislation 
was  passed  March  14,  1900;  (2)  after  the  panic  of  1907,  the 
public  expected  action  again,  but  this  great  opportunity  was 
frittered  away  by  the  Aldrich-Cannon  group — rigging  only  a 
jury-mast  in  the  Aldrich-Vreeland  Act  of  May  30,  1908,  which 
is  practically  an  expression  of  incompetence;  (3)  again,  at  the 
present  moment  public  opinion,  especially  among  business  men, 
is  becoming  impatient,  restive,  and  urgent,  after  the  constric- 
tion of  credit  last  autumn  which  was  nearly  as  severe  as  in 


154  BANKING  PROGRESS 

1907.     If  legislation  is  not  had  at  this  juncture,  it  is  likely  to 
go  over  several  years. 

8.  It  is  now  six  years  since  the  last  panic;  a  boom  in  the 
next  twelve  months  would  prepare  the  material  of  overtrading 
which  might  issue  in  an  unexpected  breakdown  of  credit  in 
the  next  two  or  three  years.  Delay  until  another  panic  has 
aroused  pubUc  opinion  would  be  ruinous  political  poUcy. 

4.  The  passage  of  tariff  bills,  on  even  one  schedule,  would 
certainly  create  more  or  less  dissatisfaction  with  any  adminis- 
tration; that  is  to  be  expected.  To  have  the  passage  of  a  con- 
structive measure  on  currency  and  banking  to  its  credit,  along- 
side of  the  tariff  revision,  would  be  an  important  offset  to  tariff 
criticism,  because  it  would  especially  appeal  to  the  business 
men  of  the  whole  country. 

5.  Whenever  monetary  legislation  becomes  imminent,  in- 
evitably countless  plans  are  proposed,  some  good,  most  cranky, 
and  persons  become  partisans  to  this  or  that  plan,  so  that  agree- 
ment is  impossible  on  any  one  measure.  Before  such  crystalli- 
zation becomes  possible,  political  sagacity  demands  the  throw- 
ing of  the  party  behind  some  bill  (already  thought  out  and  ac- 
cepted by  the  few  who  really  lead).  It  would  be  a  rallying- 
point.  Not  one  in  10,000  will  be  competent  to  judge  of  the 
bill  on  its  merits;  given  its  large,  essential  high-spots,  popularly 
put,  men  will  accept  it  on  authority. 

6.  The  indication  of  the  general  features  of  the  plan  should 
come  from  Mr.  Wilson  to  Congress  and  not  from  Congress  to 
Mr.  Wilson.  He  can  speak  for  the  people  in  demanding  the 
socializing  for  the  common  good  of  a  present  strongly  individ- 
ualistic banking  system. 

7.  The  present  is  the  critical  moment.  At  the  very  time 
when  the  Glass  subcommittee  is  nearly  ready  to  report  a  bill, 
party  leaders  are  obliged  to  consider  the  probable  programme 
for  the  extra  session.  Those  in  the  party  who  remember  their 
disasters  in  past  money  campaigns  are  naturally  disposed  to 
urge  delay.  A  dangerous  situation  may  arise,  if  both  sides 
begin  to  crystallize  into  antagonisms.  It  can  be  dissolved  in 
a  moment  by  six  lines  given  to  the  public  by  Mr.  Wilson,  say- 
ing that  banking  and  currency  legislation  should  be  taken  up 
in  the  spring  session.  The  desire  for  harmony  in  the  party  is 
so  strong  at  Washington,  and  the  will  to  help  Mr.  Wilson  so 


POLITICAL  HISTORY  OF  ACT  155 

evident,  that  such  a  declaration  by  him  to  the  country  would 
break  up  division  before  it  could  occur,  and  all  would  fall  in 
behind  the  party  measure.  Moreover,  it  is  conceivable  that 
the  authority  of  a  President  may  be  greater  now  than  later 
when  patronage  troubles  may  arise. 

8.  Finally,  early  publicity  of  the  party  bill  is  desirable.  It 
will  furnish  a  rallying-point;  discussion  and  publicity  will  be 
concentrated  on  this  to  the  exclusion  of  all  lesser  bills  and 
theories.  Moreover,  by  drawing  criticism,  it  will  afford  op- 
portunity for  later  perfecting  the  measure  during  its  passage. 

9.  In  a  tactful  way,  for  which  Mr.  Wilson  is  eminently  fitted, 
some  common  understanding  on  the  bill  should  early  be  ar- 
rived at  by  the  forces  needed  to  give  the  measure  support. 
The  measure  of  Mr.  Glass  is  likely  to  afford  a  reasonable  com- 
promise with  Mr.  Bryan  on  government  issues  and  asset- 
currency.  Also,  there  is  good  ground  for  thinking  that  the 
National  Citizens'  League  and  the  American  Bankers'  Associa- 
tion could  be  brought  to  support  it,  if  its  technical  provisions 
are  carefully  worked  out.  Some  informal  conferences  would 
settle  all  differences,  which  are  now  only  matters  of  detail,  and 
not  of  general  principle.  Thus  an  unmistakably  active  public 
opinion  could  immediately  be  created  behind  the  party  bill, 
if  Mr.  Wilson,  from  his  coign  of  vantage,  would  give  the  word. 

It  may  be  that  this  memorandum  had  no  effect  on  the 
decision  of  the  President;  but,  whatever  the  reasons 
were  which  actuated  him,  the  bill  was  in  fact  introduced 
and  passed  in  the  extra  session.  Still,  if  it  were  never 
even  seen  by  the  President,  it  presents  briefly  the  political 
situation  at  the  time  as  seen  by  one  closely  connected 
with  the  campaign. 

§  5.  The  actual  result  of  the  struggle  has  proved  to 
be  remarkably  good;  but  the  opportunity  ought  not  to 
be  let  pass  without  comment  on  our  American  method 
of  legislating  on  subjects  requiring  expert  knowledge  and 
experience.  There  is  a  certain  assumption  (with  some 
rare  exceptions)  that  election  to  the  House  or  Senate  of 


156  BANKING  PROGRESS 

our  national  Congress  makes  the  member  an  e35)ert  on 
all  subjects  that  may  come  before  hun.  In  other  words, 
even  the  members  of  committees  are  not  experts;  and 
yet  these  members  usually  insist  on  introducing  their 
personal  convictions  into  proposed  bills.  Members  often 
publish  to  the  world  by  their  questions  an  abysmal  igno- 
rance of  the  subject  before  them.  Hearings  are  usually 
held,  not  primarily  to  have  various  sides  of  the  problem 
presented  by  experts,  but  to  enable  the  ignorant  member 
to  be  taught  and  to  understand  some  of  the  obvious  parts 
of  a  proposed  measure.  In  hardly  any  other  country  in 
the  world  would  inexpert  legislators  attempt  so  to  con- 
struct a  bill.  The  matter  would  be  first  referred  to  a 
committee  of  impartial,  trusted  experts,  whose  report 
would  then  be  thoroughly  thrashed  out  by  the  legis- 
lators who  are  responsible  to  public  opinion.  Yet  with 
us,  the  fact  of  election  to  Senate  or  House  seems  to  create 
in  the  minds  of  those  elected  a  suspicion  of  outside  ad- 
vice. Since  men  who  are  primarily  politicians,  and  have 
little  or  no  expert  knowledge  or  training,  must  be  per- 
sonally convinced  before  a  bill  can  even  be  reported  from 
a  committee,  it  is  a  perpetual  wonder  that  workable  laws 
on  tech.nical  subjects  are  ever  passed.  What  is  the  con- 
clusion.'^ The  actual  process  of  legislation  is  not  what 
on  the  surface  it  seems  to  be.  The  bill  is  not  passed  on 
its  merits;  for  very  few  of  those  who  vote  on  it  know  any- 
thing of  its  merits.  This  outcome,  it  may  be  said,  is  the 
necessary  result  of  committee  government.  Not  wholly; 
because  that  theory  assumes  that  committees  are  experts, 
which  they  are  not.  The  conclusion  is  that  an  important 
act  gets  on  the  statute-books,  in  our  political  system, 
only  as  a  part  of  a  given  party  policy.  The  man  in  com- 
mand of  the  party's  fortunes,  or  the  few  leaders  who 
work  with  him,  agree  on  a  measure  and  it  is  "put  through" 


POLITICAL  HISTORY  OF  ACT  157 

by  the  dominant  party,  even  though  these  leaders  know 
very  little  of  the  subject.  The  system  as  thus  described 
is  probably  the  reason  why  our  laws  on  currency  and 
banking  have  been  so  defective;  and  it  may  also  explain 
why,  by  a  happy  conjunction  of  events,  a  remarkably 
good  act  has  been  passed,  although  few  of  those  who 
passed  it  really  understood  the  essential  features  of  it. 

§  6.  The  problem  of  banking  and  currency  reform 
was  complicated  by  a  confusion  of  mind,  even  among 
bankers,  in  regard  to  the  various  kinds  of  banking  which 
might  be  carried  on  by  any  one  institution.  We  were 
in  the  midst  of  an  evolution,  not  only  in  our  business, 
but  in  our  credit,  organization.  The  banking  organism, 
which  had  seemed  fairly  homogeneous,  began  to  be  re- 
solved (as  if  by  some  gigantic  magnifying-glass)  into  parts 
having  separate  functions  and  purposes.  Already  the 
trust  companies,  organized  under  State  laws,  while  re- 
taining their  original  departments,  had  developed  depart- 
ments for  commercial  banking  creating  demand-liabilities. 
Meanwhile  national  banks,  although  essentially  com- 
mercial institutions,  began  to  establish  savings  depart- 
ments. Then,  the  growth  of  investment  banking,  and 
the  promotion  and  distribution  of  securities  to  meet  the 
phenomenal  growth  of  savings  by  investors  large  and 
small,  in  a  country  of  rapidly  expanding  wealth,  assumed 
an  overshadowing  magnitude,  and  colored  the  whole 
character  of  American  banking  and  finance.  In  addi- 
tion, the  fact,  well  known  to  economists,  began  to  be 
recognized  by  Americans  generally,  that  we  had  no  in- 
stitutions to  cover  the  demands  for  agricultural  credits 
in  rural  districts.  The  interrelations  and  analysis  of 
these  elements  in  our  banking  system  are  alluring  and 
need  a  large  treatment  by  themselves,  but  this  must  be 


158  BANKING  PROGRESS 

reserved  for  another  time  and  place;  it  is  possible  here 
only  to  refer  to  them  in  order  to  get  a  fairly  clear  under- 
standing of  the  new  legislation  of  1913. 

Most  of  the  national  banks,  as  well  as  those  under  a 
State  system,  were  carrying  on  two  distinct  kinds  of 
banking  under  one  management.  The  test  of  a  com- 
mercial bank  is  that  it  creates  demand-liabilities;  con- 
sequently, it  should  hold  only  assets  (chiefly  the  results 
of  loans  at  short  time  based  on  actual  transactions  in 
goods)  that  are  liquid  and  can  be  quickly  or  frequently 
converted  into  cash.  The  creation  of  demand-liabilities 
(chiefly  in  the  form  of  demand-deposits)  requires  as  a 
condition  of  sound  banking  a  special  kind  of  assets  readily 
adapted  to  meet  an  instant  demand  for  cash  from  cus- 
tomers. But  the  holding  of  investment  securities  by 
commercial  banks  has  reached  enormous  figures;  and 
any  general  demand  for  liquidation  of  long-time  securi- 
ties in  cash  could  not  be  met;  because  an  offer  on  a  large 
scale  would  result  in  a  great  fall  in  the  stock-market,  in 
the  weakening  of  collateral  held  for  loans,  and  an  impair- 
ment of  all  credits,  without  creating  the  coveted  cash. 
The  desire  to  share  in  the  profits  of  promotions  led  com- 
mercial banks  to  tie  up  resources  in  non-liquid  form,  with 
the  expected  results  in  time  of  panic.^ 

This  confusion  between  commercial  and  investment 
banking,   which   was  characteristic  of  the  great  cities, 

*  The  holdings  of  securities  other  than  United  States  bonds  by  all  national 
banks,  on  January  13,  1914,  were  $1,020,494,711,  of  which  $560,246,910,  or 
more  than  one-half,  were  held  by  banks  in  the  Eastern  States  (New  York,  New 
Jersey,  Pennsylvania,  Delaware,  and  Maryland);  $45,255,914  by  the  Southern 
States;  $215,119,106  by  the  Middle  Western  States;  $34,792,121  by  the  Western 
States,  and  $65,155,202  by  the  Pacific  States.  It  is  to  be  noted,  however, 
that  the  national  banks  on  the  same  date  show  savings-deposits  (presumably 
time-deposits)  of  $855,914,458,  of  which  country  banks  held  $755,914,458. 
For  a  further  study  of  the  legality  and  policy  of  security  holdings  of  national 
banks,  cf.  J.  H.  Hollander,  American  Economic  Review,  December,  1913,  and 
J.  V.  Hogan,  Journal  of  Political  Economy,  November,  1913. 


POLITICAL  HISTORY  OF  ACT  159 

found  a  counterpart  in  the  small  rural  banks  of  the  West 
and  South.  They  too  held  investment  securities;  but 
they  confused  two  distinct  kinds  of  banking  in  a  different 
way.  National,  as  well  as  State,  banks  in  rural  com- 
munities created  demand-liabilities;  but  because  short- 
time  commercial  paper  was  often  limited  in  supply,  and 
because  there  were  no  institutions  dealing  with  agricul- 
tural credits,  the  rural  banks  to  a  greater  or  less  extent 
put  their  resources  into  paper  based  on  land,  or  in  non- 
liquid  form.  The  confusion  in  regard  to  different  kinds 
of  banking  in  rural  districts  was  thus  matched  by  that  in 
the  great  cities.  The  consequences  were  obvious:  in 
the  latter  the  essentials  of  reform  were  obscured  by  the 
hue  and  cry  about  "Wall  Street  control,"  which  orig- 
inated really  from  the  prevalence  of  promotions  and  loans 
on  securities;  while  in  the  former,  the  desire  to  help  the 
under  dog  (or  small  bank)  led  to  provisions  for  rural  loans 
on  land  wholly  inconsistent  with  the  refusal  to  accept 
loans  on  stock-exchange  collateral.  Such  is  the  way  of 
legislation  in  a  democracy. 


CHAPTER  IX 
A  PROPOSED  BILL 

§  1.  The  author  had  been  a  member  of  the  Indianap- 
olis Monetary  Commission  and  drew  up  the  report  of 
1898;  he  had  been  called  in  to  aid  in  preparing  the  bill 
of  the  American  Bankers'  Association  in  1908;  after  the 
tentative  draft  of  the  Aldrich  Bill  was  made,  he,  like 
many  others,  was  asked  for  suggestions,  but  had  nothing 
to  do  with  its  main  formulation;  and  in  1911-1913,  being 
charged  with  the  conduct  of  a  nation-wide  campaign  of 
education  on  banking  reform,^  he  was  also  permitted  to 
offer  his  own  suggestions  to  the  Glass  subcommittee  in 
the  winter  of  1912-1913.  These  suggestions  were  put 
into  the  form  of  a  bill  with  a  running  commentary  on 
various  sections.  Moreover,  while  fully  understanding 
that  no  one  draft  was  likely  to  be  adopted  in  toto  by  the 
framers  of  the  new  legislation,  he  was  led  to  present  a 
complete  bill  containing  in  it  some  features,  especially 
regarding  the  note-issues,  which  were  too  ideal  to  get 
into  this  law;  but  these  provisions  are  here  retained  as 
part  of  the  material  out  of  which  the  general  result  was 
created.  They  may  have  some  bearing  on  the  banking 
development  of  the  future.  It  may  be  that  some  of  his 
suggestions  were  incorporated  in  the  final  act,  but  he 
was  content  with  throwing  his  material  into  the  common 
pot,  out  of  which  an  admirable  and  lasting  piece  of  legis- 

'  He  was  chairman  of  the  Executive  Committee  of  the  National  Citizens* 
League,  whose  ruling  board  was  composed  of  Chicago  business  men.  He  also  had 
valuable  aid  in  this  work  from  Professor  W.  A.  Scott,  of  the  University  of 
Wisconsin,  and  Professor  M.  S.  Wildman,  of  Stanford  University. 

160 


A  PROPOSED  BILL  161 

lation  emerged.  By  presenting  in  this  chapter  his  pro- 
posed bill  ^  (for  which,  although  aided  by  many  others,  he 
assumes  all  responsibility),  it  can  easily  be  compared  by 
the  student  with  the  Federal  Reserve  Act.  Apart  from 
technical  banking  provisions,  of  course  the  main  interest 
centred  on  questions  of  organization  and  control,  in- 
cluding the  matter  of  centralization;  elasticity  and  se- 
curity of  note-issues;  the  elasticity  of  credit;  the  transi- 
tion from  the  old  bond-secured  circulation  to  the  new 
systems;  the  co-operative  holding  of  reserves;  foreign 
banking;  and  clearings  under  a  new  system. 

§  2.  Out  of  the  discussion  on  currency  reform  for  the 
eighteen  months  preceding  December,  1912,  there  had 
been  reached  on  certain  points  a  general  agreement,  which 
may  be  briefly  summarized; 

1.  The  need  of  some  co-operative  agency  for  rediscounting 
commercial  paper  in  time  of  pressure,  in  order  to  prevent  panics. 
This  would  supplant  the  partial,  voluntary  work  of  clearing- 
houses in  the  past. 

2.  A  cessation  of  the  present  scattering  of  reserves,  and  their 
mobilization  in  the  common  interest  of  all  banks. 

3.  A  control  over  the  possible  expansion  of  credit  and  the 
speculative  use  of  idle  funds.     Control  of  the  rate  of  discount. 

4.  An  elastic  currency.  The  abolition  of  the  system  of 
bond-secured  national  bank  notes. 

5.  Bankers'  acceptances  of  commercial  paper  to  be  allowed 
to  national  banks. 

6.  The  co-operative  discount  institution  to  be  made  the 
fiscal  agent  of  the  United  States  Treasury. 

7.  Banking  institutions  to  be  estabUshed  in  foreign  coun- 
tries to  aid  American  trade. 

'  As  to  the  charge  that  this  bill  was  a  disguised  form  of  the  Aldrich  Bill,  any 
one  who  had  read  both  would  see  the  falsity  of  the  charge.  Cf.  also  the  attack 
on  this  bill  in  the  hearings  before  the  Senate  Committee  on  Banking,  63d  Con- 
gress, 1st  session,  part  23,  p.  1811,  and  part  38,  p.  3013. 


162  BANKING  PROGRESS 

Banking  reform  was  tied  up  with  currency  reform,  be- 
cause banks  in  this  country  provide  a  currency  in  the 
form  of  checks  drawn  on  deposits,  and  because  the  ques- 
tion of  the  organization  of  credit  is  even  more  important 
than  the  issue  of  bank-notes.  The  unnecessary  expense 
of  obtaining  credit  under  a  bad  banking  system  is  borne 
by  the  borrower;  the  impossibihty  of  getting  loans  in  a 
time  of  stringency,  or  panic,  shuts  up  factory  and  shop 
and  falls  most  severely  upon  the  wage-earner,  who  loses 
his  employment.  The  defects  of  our  banking  and  cur- 
rency system  are  obvious. 

It  has  long  been  seen  that  our  currency  is  needlessly 
inelastic;  that  our  credit  system  is  even  more  danger- 
ously inelastic;  that  our  large  gold  supply  is  inefifectively 
used;  that  the  scattering  of  reserves  forbids  co-operative 
action  by  the  banks  in  time  of  stress;  that  our  rigid  re- 
serve system  even  breeds  panics;  that  State  banks  and 
trust  companies  are  doing  commercial  banking,  but  with- 
out co-operation  with  national  banks;  that  our  inde- 
pendent subtreasury  often  attacks  the  reserves  of  banks 
at  times  of  danger  and  works  without  businesslike 
economy  and  efficiency;  that  idle  funds  of  banks  drift 
to  New  York,  and  on  call  loans  feed  stock  speculation; 
and  that  our  trade  is  greatly  hampered  by  lack  of  Ameri- 
can banking  facilities  in  foreign  countries. 

The  defects  of  the  present  currency  system  are  so  ob- 
vious that  there  is  a  general  consensus  of  opinion  that 
something  must  be  done.  Legislation  of  some  sort  is 
inevitable.  The  Monetary  Commission  Plan  has  been 
politically  antagonized.  Some  other  plan,  different  but 
sound,  must  be  brought  forward;  one  whose  control  could 
not  pass  into  the  hands  of  an  ambitious  financial  group. 
The  present  problem,  therefore,  is  to  find  the  best  con- 
crete machinery  for  carrying  out  the  points  on  which 
there  is  pretty  general  agreement. 


A  PROPOSED  BILL  163 

The  emphasis  of  the  opposition  has  been  put  on  the 
fear  of  control  by  "Wall  Street."  It  is  a  question,  there- 
fore, whether  any  organization  is  possible,  which  would 
give  the  necessary  oversight  of  the  rediscounts  in  all  parts 
of  the  country  and  the  mobilization  of  the  reserves  to  be 
directed  in  the  common  interest  at  the  place  of  weakness 
and  danger.  In  short,  can  we  have  an  organization  some- 
what like  a  central  clearing-house,  which  would  do  for 
all  the  banks  in  the  country  what  a  clearing-house  asso- 
ciation now  does  for  the  banks  in  one  city?  If  so,  the 
mechanism  must  be  so  simple  that  attempts  to  control 
it  would  be  instantly  perceived  and  be  immediately  frus- 
trated. In  order  to  prevent  possible  domination,  either 
considerable  government  control  (which  runs  the  risk  of 
the  greater  danger  of  political  control),  or  some  division 
of  the  agencies  of  rediscount  into  local  organizations, 
like  present  clearing-houses  in  the  main  cities,  or  trading 
centres,  have  been  proposed.  Perhaps,  the  true  solu- 
tion lies  between  the  two:  the  relegation  of  discount- 
making  to  branches  or  local  institutions,  with  managers 
chosen  by  local  boards,  but  who  would  be  under  super- 
vision by  some  general  board;  and,  then  such  govern- 
ment supervision  of  this  board  as  will  assure  freedom  from 
any  dominant  financial  control,  but  not  going  so  far  as 
to  allow  any  interference  from  politics.  Unity  of  action 
is  indispensable;  but  so  is  freedom  from  domination  by 
any  selfish  poKtical  or  financial  interests. 

§  3.  The  reorganization  of  our  credit  system  along 
democratic  lines,  at  the  same  time  that  an  elastic  cur- 
rency is  provided,  demands  nothing  novel  or  disturbing, 
if  it  be  accommodated  to  what  has  already  been  evolved 
out  of  our  experience.  In  brief,  this  accompanying  mea- 
sure is  built  up  on  the  basis  of  our  clearing-houses,  in  which 
we  find  there  has  grown  up  a  mechanism  to  meet  prac- 


164  BANKING  PROGRESS 

tical  difficulties  which  has  not  yet  been  overtaken  or 
recognized  by  legislation.  By  building  up  the  co-opera- 
tive discounting  institutions  upon  the  basis  of  the  exist- 
ing clearing-houses  of  the  chief  trading  centres  of  the 
country,  we  regularize  extralegal  and  voluntary  opera- 
tions which  have  grown  to  enormous  importance.  This 
bill  simply  attempts  to  keep  pace  with  the  past  growth 
of  experience;  it  does  not  overthrow;  it  supplements; 
and  puts  under  legal  direction  what  is  now  under  private 
control,  although  quasi-public  in  character. 

Because  of  the  lack  of  any  regulation  of  credit,  clear- 
ing-houses grew  up  of  necessity.  They  perform  two 
functions:  (1)  offsetting  of  checks  drawn  on  or  against 
the  banks  of  a  city,  obviating  all  payments  but  balances; 
(2)  from  this  co-operation  the  banks  were  led  into  a  far 
more  important  co-operation,  to  help  out  a  weaker  mem- 
ber by  combining  resources  and  issuing  clearing-house 
certificates  when  the  credit  system  had  broken  down. 
This  last  was  a  rediscounting  operation,  turning  banking 
assets  into  a  means  of  meeting  clearing-house  balances. 

It  has  been  charged  that  favoritism,  or  injustice,  to 
banks  has  crept  in,  which  could  not  be  controlled,  because 
clearing-houses  were  voluntary,  unincorporated,  extra- 
legal institutions.  If  so,  this  bill,  which  establishes  dis- 
trict associations  upon,  and  in  lieu  of,  the  chief  clearing- 
house associations,  would  regularize  all  such  operations 
and  bring  them  under  the  supervision  of  the  government. 

Because  each  district  association  is  solely  a  discounting 
institution — devised  to  accomplish  the  reorganization  of 
credit  under  the  direction  of  law — it  must  have  its  own 
capital  drawn  from  its  membership  in  its  own  section. 
This  arrangement  localizes  control  in  making  loans,  and 
requires  democratic  equality  of  treatment  for  every  bank 
in  a  given  district.    It  admits  State  as  well  as  national 


A  PROPOSED  BILL  165 

banks.  As  banks  in  a  city  co-operate  to  secure  protec- 
tion in  the  common  interest,  so  the  banks  in  a  district 
(of  which  districts  there  may  be  five  or  more)  co-operate 
»  to  prevent  selfish  individualistic  grasping  for  reserves  in 
a  time  of  alarm.  In  this  way  reserves  are  mobilized  for 
a  large  section  of  the  country  so  that  no  legitimate  bor- 
rower in  that  territory  need  fail  in  getting  credit  and  the 
means  of  payment,  no  matter  what  the  stringency  may 
be.  Moreover,  loans  are  limited  to  mercantile  business, 
and  not  granted  for  stock-exchange  transactions. 

Therefore,  unity  of  action  and  equahty  of  treatment 
throughout  the  country  demand,  in  addition,  much  the 
same  supervision  of  all  the  district  associations  as  the 
individual  banks  receive  in  any  one  district.  It  is  pro- 
posed to  gain  this  end  by  a  general  supervisory  board, 
called  the  treasury  board,  without  any  capital.  In  brief, 
the  treasury  board  co-ordinates  the  various  district  asso- 
ciations much  as  a  clearing-house  committee  co-ordinates 
the  banks  in  any  one  city.  Thereby  the  fangs  are  drawn 
from  any  objection  based  on  the  possibility  of  one  cen- 
tralized institution,  with  a  large  capital,  which  might  be 
dominated  by  "Wall  Street"  or  by  any  selfish  interest. 
The  selection  of  this  supervisory  treasury  board  is  made 
simple  and  plain  enough  to  be  free  from  all  suspicion.  It 
should  provide  for  an  equal  representation  by  the  three 
interests  affected  by  the  bill:  (1)  the  bankers,  (2)  the  bor- 
rowing business  public,  and  (3)  the  government  of  the 
United  States. 

Having  thus  provided  for  the  reorganization  of  credit, 
i  the  elasticity  of  the  currency  is  obtained  in  connection 
with  the  discounting  agencies,  the  district  associations, 
but  through  the  treasury  board  in  such  a  way  as  to  throw 
the  limehght  on  the  safety  and  management  of  the  note- 
issues.    It  is  admitted  by  all  that  the  bond-secured  na- 


166  BANKING  PROGRESS 

tional  b^nk  notes  are  inelastic  and  should  be  abolished. 
The  first  alternative  is  the  retention  of  note-issues  by 
the  individual  national  banks,  based  solely  on  general 
assets.  To  avoid  the  ** asset-currency"  of  individual 
banks,  this  bill  takes  the  issue  of  notes  away  from  the 
individual  banks  and  places  it  in  the  hands  of  the  treasury 
board  under  the  close  supervision  of  the  government — 
while  yet  making  them  safe  beyond  question  by  a  lien 
on  all  the  assets  of  the  district  associations.  Thus  all 
the  expense  of  redemption  and  of  reserves  is  put  upon  the 
banks  and  not  upon  the  government,  while  the  super- 
vision is  in  the  body  in  which  the  government  is  fully 
represented.  This  outcome  is  an  obvious  compromise 
between  issues  solely  by  banks  and  issues  solely  by  the 
government.  Such  an  adjustment  may  possibly  be  found 
in  the  accompanying  bill. 

§4.  An  act  to  introduce  into  the  banking  and  currency 
system  of  the  United  States  elasticity  of  credit  and  circulation 
through  the  establishment  of  district  associations  and  a  trea- 
sury board. 

Be  it  enacted  by  the  Senate  and  House  of  Representatives 
of  the  United  States  of  America  in  Congress  assembled: 

Sec.  1.  That  the  Treasury  Board  of  the  United  States  be, 
and  is  hereby,  established  in  Washington,  in  the  District  of 
Columbia,  to  consist  of  the  Secretary  of  the  Treasury,  the 
Comptroller  of  the  Currency  and  five  other  members,  of  whom 
four  shall  be  appointed  by  the  President  of  the  United  States. 
The  fifth  member  shall  be  chosen  by  the  Board  as  aheady  con- 
stituted, and,  with  the  approval  of  the  President  of  the  United 
States,  he  shall  be  the  chairman  of  the  Board  and  the  manager 
thereof.  The  manager  shall  hold  office  for  ten  years  unless 
previously  removed  for  cause  by  the  President,  or  by  a  two- 
thirds  vote  of  the  other  members  of  the  Board.  The  Manager 
shall  receive  a  salary  of  twelve  thousand  dollars  per  annum. 
The  four  members  appointed  by  the  President  shall  hold  office 
for  five  years,  and  may  be  reappointed,  and  each  of  said  ap- 


A  PROPOSED  BILL  167 

pointees  shall  receive  a  salary  of  eight  thousand  dollars  per 
annum.  The  term  of  service  of  members  of  the  Treasury  Board 
shall  date  from  the  day  when  this  act  shall  go  into  force. 

Sec.  2.  That  there  shall  be  established  in  any  centre  of 
trade  in  the  United  States  which  may  be  designated  by  the 
Treasury  Board,  a  District  Association  for  a  term  of  twenty 
years  from  the  date  when  this  act  shall  go  into  effect.  At  the 
expiration  of  said  term  of  twenty  years,  if  this  act  has  not 
been  specifically  repealed,  said  District  Association  shall  con- 
tinue for  another  period  of  twenty  years,  and  unless  said  act 
has  been  repealed  at  the  end  of  a  second  period  of  twenty 
years,  said  Associations  shall  continue  in  existence  until  said 
act  may  be  repealed;  Provided,  however,  that  Congress  may 
alter  or  amend  the  provisions  of  this  act  to  take  effect  at  the 
end  of  successive  periods  of  ten  years  after  its  passage. 

Sec.  3.  Each  District  Association  shall  have  an  authorized 
capital,  divided  into  shares  of  $100  each,  equal  in  amount  to 
10  per  cent  of  the  paid-in  capital  and  surplus  of  all  qualifying 
banks  constituting  its  membership,  as  hereinafter  indicated, 
of  which  capital  5  per  cent  must  be  paid  in  in  cash  before  it  is 
authorized  to  begin  business.  No  District  Association  shall  be 
given  a  certificate  of  incorporation,  or  be  allowed  to  begin 
business  by  the  Treasury  Board,  unless  the  total  amount  of 
its  paid-up  capital  shall  be  equal  to,  or  shall  exceed,  $10,000,000. 

Sec.  4.  Within  thirty  days  after  the  passage  of  this  act, 
the  Treasury  Board  shall  inform  each  national  bank  and  each 
bank  and  trust  company  incorporated  under  the  laws  of  any 
State  or  of  the  District  of  Columbia  of  the  conditions  prescribed 
for  membership  in  said  District  Associations.  Said  Treasury 
Board  shall  designate  the  cities,  or  trade  centres,  in  which  a 
District  Association  shall  be  placed,  and  define  the  territory 
of  each,  mdicating  the  District  iVssociation  of  which  each  quali- 
fying bank  or  trust  company  shall  be  a  member. 

Sec.  5.  In  order  to  qualify  as  a  member  of  a  District  Asso- 
ciation, a  national  bank,  or  a  bank  or  trust  company  doing  a 
commercial  banking  business  incorporated  under  the  laws  of 
any  State  or  of  the  District  of  Columbia,  must  conform  to  the 
following  requirements : 

1.  It  must  have  subscribed  to  the  stock  of  its  District  Associa- 
tion, as  designated  by  the  Treasury  Board,  an  amount  equal 


168  BANKING  PROGRESS 

to  10  per  centum  of  its  paid-in  capital  and  surplus;  and  it 
must  have  paid  in,  in  such  manner  as  may  be  indicated  by  said 
Treasury  Board,  in  full  legal  tender  money  or  national  bank 
notes,  one-half  of  the  capital  stock  thus  subscribed. 

The  subscriptions  of  a  bank  or  trust  company  incorporated 
under  the  laws  of  any  State  or  of  the  District  of  Columbia  to 
the  capital  stock  of  a  District  Association  shall  be  made  sub- 
ject to  the  following  conditions: 

That  (a)  if  a  bank,  it  shall  have  a  paid-in  and  unimpaired 
capital  of  not  less  than  that  required  for  a  national  bank  in 
the  same  locality;  and  that  (6)  if  a  trust  company,  it  shall  have 
an  unimpaired  surplus  of  not  less  than  twenty  per  centum  of  its 
capital,  and  if  located  in  a  place  having  a  population  of  six 
thousand  inhabitants  or  less,  shall  have  a  paid-in  and  unim- 
paired capital  of  not  less  than  fifty  thousand  dollars;  if  located 
in  a  city  having  a  population  of  more  than  six  thousand  in- 
habitants and  not  more  than  fifty  thousand  inhabitants,  shall 
have  a  paid-in  and  unimpaired  capital  of  not  less  than  one 
hundred  thousand  dollars;  if  located  in  a  city  having  a  popula- 
tion of  more  than  fifty  thousand  inhabitants  and  not  more 
than  two  hundred  thousand  inhabitants,  shall  have  a  paid-in 
and  unimpaired  capital  of  not  less  than  two  hundred  thousand 
dollars;  if  located  in  a  city  having  a  population  of  more  than 
two  hundred  thousand  inhabitants,  and  not  more  than  three 
hundred  thousand  inhabitants,  shall  have  a  paid-in  and  un- 
impaired capital  of  not  less  than  three  hundred  thousand  dollars; 
if  located  in  a  city  having  a  population  of  more  than  three  hun- 
dred thousand  inhabitants  and  not  more  than  four  hundred 
thousand  inhabitants,  shall  have  a  paid-in  and  unimpaired 
capital  of  not  less  than  four  hundred  thousand  dollars;  and  if 
located  in  a  city  having  a  population  of  more  than  four  hundred 
thousand  inhabitants,  shall  have  a  paid-in  and  unimpaired 
capital  of  not  less  than  five  hundred  thousand  dollars. 

2.  It  must  carry  such  reserves  as  are  required  in  Sec.  28  of 
this  act,  comply  with  all  the  regulations  regarding  reports  and 
examinations,  or  any  other  regulations  imposed  by  this  act  or 
involved  in  the  execution  of  its  provisions,  and  promptly  meet 
all  its  obligations  to  its  District  Association. 

3.  If  a  national  bank,  it  must  present  a  certificate  from  the 
Comptroller  of  the  Currency  that  its  affairs  have  been  in  good 


A  PROPOSED  BILL  169 

order  for  the  preceding  twelve  months;  if  a  State  bank  or  trust 
company,  it  must  present  a  similar  certificate  from  the  banking 
department  of  its  State. 

4.  Any  qualified  bank  or  trust  company  may  withdraw  from 
membership  in  its  District  Association  by  giving  60  days  notice 
in  writing  of  its  intention  to  withdraw,  and  by  meeting  all  its 
obligations  to  the  Association,  including  the  payment  of  its 
'pro  rata  share  of  any  losses  that  may  have  occurred.  Said 
Association  shall  be  allowed  four  months  after  the  actual  with- 
drawal in  which  to  repay  to  said  withdrawing  member  its  con- 
tribution to  the  capital  stock  of  said  Association;  but  in  no 
case  shall  more  than  the  amount  paid  in  to  the  capital  stock 
of  said  Association  be  returned. 

5.  Upon  the  fulfilment  of  the  conditions  herein  stated,  the 
Treasury  Board,  through  its  duly  authorized  officer,  shall  issue 
to  each  District  Association  a  certificate  of  incorporation, 
for  a  term  of  twenty  years  from  the  date  when  this  act  shall  go 
into  effect,  duly  countersigned  by  the  Manager  of  the  Treasury 
Board  and  the  Comptroller  of  the  Currency. 

Sec.  6.  Upon  the  issue  to  each  District  Association  of  said 
certificate  of  incorporation,  as  above  described,  said  District 
Association  shall  become,  and  is  hereby  created,  a  body  cor- 
porate, and  as  such  and  by  that  name,  to  which  shall  be  at- 
tached the  number  of  the  District,  shall  have  power: 

First:  To  adopt  and  use  a  corporate  seal. 

Second :  To  have  succession  for  a  period  of  twenty  years  from 
the  date  of  this  act. 

Third:  To  make  all  contracts  necessary  and  proper  to  carry 
out  the  powers  granted  to  said  District  Association  by  this 
act. 

Fourth:  To  sue  and  be  sued,  complain  and  defend,  in  any 
court  of  law  or  equity,  as  fully  as  natural  persons. 

Fifth:  To  select  or  appoint  directors  and  officers  in  the 
manner  hereinafter  provided  and  define  their  duties. 

Sixth:  To  adopt  by  its  Board  of  Directors  by-laws  not  in- 
consistent with  this  act,  regulating  the  manner  in  which  its 
property  shall  be  transferred,  its  general  business  conducted, 
and  the  privileges  granted  to  it  by  law  exercised  and  enjoyed, 
subject  to  the  authority  of  the  Treasury  Board,  as  may  be  stated 
in  this  act. 


170  BANKING  PROGRESS 

Seventh:  To  purchase,  acquire,  hold  and  convey  real  estate 
as  hereinafter  provided. 

Eighth:  To  exercise  by  its  Board  of  Directors  or  duly  au- 
thorized committees,  officers,  or  agents,  subject  to  law,  all  the 
powers  and  pri\'ileges  conferred  upon  said  District  Association, 
subject  to  the  authority  of  the  Treasury  Board,  as  may  be 
stated  in  this  act. 

Ninth:  To  p^o^^de  as  far  as  possible  for  the  clearing  of  checks 
and  drafts  between  different  qualifying  banks  and  between  dif- 
ferent District  Associations. 

Sec.  7.  The  Board  of  Directors  of  each  District  Associa- 
tion shall  be  elected  as  follows: 

The  subscribing  banks  in  each  district,  and  exclusive  of  the 
banks  which  are  members  of  the  clearing-house  of  the  city  in 
which  the  District  Association  is  situated,  shall  be  divided  by 
the  Bank  Commission  or  by  the  Treasury  Board  territorially  into 
six  groups,  each  of  which  groups  shall  elect  one  director;  each 
bank  having  one  vote. 

Three  additional  directors  shall  be  named  by  the  clearing- 
house of  the  city  in  which  the  District  Association  is  situated. 

The  Treasury  Board  shall  select  five  more  directors  from  a 
list  of  fifteen  nominees  chosen  by  the  nine  directors  aheady 
elected,  which  nominees  shall  not  be  officers  of  any  banking 
institution  (directors  of  banks  not  being  regarded  as  officers) 
and  who  shall  represent  the  chief  agricultural,  industrial  and 
commercial  interests  of  the  district. 

The  fourteen  directors  thus  chosen  shall  select  from  outside 
their  number  a  person  who  shall  constitute  the  fifteenth  mem- 
ber of  the  Board  and  be  its  presiding  officer  and  manager  of  the 
District  Association,  provided  this  choice  be  ratified  by  the 
Treasury  Board. 

The  term  of  office  of  the  manager  shall  be  five  years,  but  he 
may  be  at  any  time  removed  for  cause  by  the  Board  of  Directors. 

The  Board  of  Directors  of  each  Association  shall  also  ap- 
point an  Executive  Committee  of  not  less  than  three  nor  more 
than  five  from  its  members,  of  which  the  manager  shall  be  ex 
officio  chairman. 

An  Examining  Board  shall  be  appointed  by  the  Board  of 
Directors  of  the  District  Association,  who  shall  examine  into 
and  report  on  the  condition  of  the  qualified  banks  within  the 


A  PROPOSED  BILL  171 

district  assigned  to  each,  and  shall  furnish  to  the  District  Asso- 
ciation all  information  necessary  for  the  proper  selection  of  the 
paper  presented  for  discount. 

§  5.  The  provisions  of  the  bill  regarding  discounts 
are  as  follows: 

Sec.  8.    The  business  of  the  District  Associations  shall  be: 
(a)  To  receive  from  any  qualifying  institution  within  its 
district  deposits  of  lawful  money  and  national  bank  notes. 

(6)  To  discount  to  the  extent  that  its  resources  and  the  pro- 
visions of  this  act  permit  for  properly  qualified  institutions 
paper  of  the  following  kinds: 

(1)  Such  notes  and  bills  of  exchange  as  have  been  received 
in  the  course  of  business,  which  bear  the  indorsement  of  the 
institution  presenting  them  for  discount  and  which  mature 
in  not  more  than  60  days,  excepting  such  notes  and  bills  of 
exchange  as  are  issued  or  drawn  for  the  purpose  of  carrying 
stocks,  bonds,  or  other  investment  securities; 

(2)  Acceptances  of  national  banks  made  in  pursuance  of  the 
provisions  of  Sec.  10  of  this  act,  or  acceptances  of  other  quali- 
fied banks,  which  are  based  on  travellers'  credits  or  on  the  ex- 
portation, or  importation  of  the  products  of  the  soil,  mines, 
or  of  manufacture,  and  which  mature  in  not  more  than  90 
days  and  bear  the  signature  of  at  least  one  bank  in  addition 
to  that  of  the  acceptor; 

(3)  The  direct  obligations  of  qualified  institutions  under  the 
following  conditions:  Application  for  the  privilege  of  making 
such  discounts,  designating  the  amounts,  the  collateral  offered 
and  the  institutions  applying  for  them,  must  be  made  to  the 
Manager  of  the  Treasury  Board.  If  in  his  opinion  such  dis- 
counts are  required  in  the  mterests  of  the  public,  and  if  such 
opinion  is  approved  by  a  majority  vote  of  the  Treasury  Board, 
and,  also,  if  such  opinion  is  approved  by  the  Secretary  of  the 
Treasury,  the  privilege  may  be  granted.  Provided  the  collateral 
pledged  shall  be  of  unquestioned  soundness;  and  that  the 
amount  of  the  loan  shall  not  exceed  75  per  cent  of  the  market 
value  of  the  securities  pledged. 

The  total  amount  of  discounts  granted  to  any  one  qualified 


172  BANKING  PROGRESS 

bank  by  any  District  Association  shall  not  exceed  a  sum  equal 
to  the  amount  of  the  capital  of  said  borrowing  bank. 

Whenever  the  amount  of  discounts  granted  to  any  one  quali- 
fied bank  by  any  District  Association  shall  equal  50  per  cent 
of  its  paid-in  capital,  any  discounts  in  excess  of  said  50  per 
cent  shall  be  charged  a  commission,  as  follows:  between  50 
and  60  per  cent,  one  per  cent;  between  60  and  80  per  cent, 
two  per  cent;  between  80  and  100  per  cent,  three  per  cent. 

Sec.  9.  The  functions  of  rediscounting,  or  the  issue  of 
clearing-house  certificates,  by  existing  or  future  clearing-house 
associations,  are  hereby  forbidden,  it  being  assumed  that  such 
functions  of  existing  clearing-house  associations  are  exercised 
solely  by  the  District  Associations. 

Sec.  10.  National  banks  are  hereby  authorized  to  accept 
drafts  or  bills  of  exchange  drawn  upon  them,  having  not  more 
than  four  months  to  run,  accompanied  by  the  documentary 
evidence  of  the  nature  of  the  transaction  which  must  be  based 
on  the  movement  of  goods  from  the  producer  to  the  consumer, 
and  were  not  drawn  for  the  purpose  of  carrj^ing  stocks,  bonds 
or  other  investment  securities. 

Sec.  11.  Each  District  Association  shall  have  authority  to 
fix  the  rates  of  discount  from  time  to  time,  which  rate  when  so 
fixed  shall  be  published,  and  shall  be  uniform  within  its  District, 
Provided,  that  the  Treasury  Board  shall  have  authority  both 
to  veto  any  proposed  changes,  or  to  order  changes,  in  rates. 

Section  8  of  the  bill  authorizes  the  district  associa- 
tions to  render  two  kinds  of  services  to  the  qualifying 
institutions  in  their  districts,  namely,  the  administra- 
tion of  their  reserves,  and  rediscounting. 

In  the  description  of  the  paper  which  the  district  asso- 
ciations are  to  be  permitted  to  discount,  described  in 
(h)  (1),  (2),  and  (3),  the  following  points  are  important: 
The  limitation  of  discounts  to  paper  which  arises  from 
the  general  movement  of  goods  from  producer  to  con- 
sumer; the  permission  to  discount  both  promissory  notes 
and  bills  of  exchange  which  answer  this  description;  the 
requirement  that  all  such  paper  must  bear  the  indorse- 


A  PROPOSED  BILL  173 

ment  of  the  bank  presenting  It  for  discount;  and  that  It 
must  mature  in  sixty  days  or  less.  It  is  undesirable  to 
introduce  rigid  definitions  into  the  law  which  lead  to 
difficulties  that  the  experience  with  the  National  Banking 
Act  shows  have  often  arisen.  Inevitably  much  must  be 
left  to  the  management.  The  phraseology  used  in  Sec- 
tion 8  defining  the  paper  has  been  the  result  of  much 
consultation  with  practical  bankers. 

Some  persons  have  doubted  the  advisability  of  permit- 
ting the  district  associations  to  discount  promissory  notes 
on  the  ground  that  such  permission  would  allow,  and 
perhaps  encourage,  the  continuation  of  the  confusion  of 
commercial  and  investment  banking  now  almost  uni- 
versal in  this  country,  while  the  limitation  of  discounts 
to  commercial  bills  of  exchange  and  bank  acceptances  of 
a  commercial  character  would  discourage  existing  bank 
practices  and  help  to  remove  this  confusion  by  forcing 
banks  to  put  pressure  upon  their  customers  for  the  pur- 
pose of  bringing  back  into  use  again  the  old  commercial 
bill  of  exchange.  It  would  probably  be  difficult,  how- 
ever, and  perhaps  Impossible  to  change  business  habits 
in  this  respect  immediately,  and  if  so,  the  district  associa- 
tions should  not  be  prohibited  from  discounting  promis- 
sory notes  in  the  meantime.  The  desirability  of  setting 
some  limit  to  the  length  of  time  during  which  discounts 
of  this  character  are  to  be  permitted,  however,  is  worthy 
of  serious  consideration. 

It  is  desirable  that  the  district  associations  should  con- 
fine their  discounts  to  as  short-term  paper  as  possible, 
and  sixty  days  seems  to  be  a  reasonable  period  both  from 
the  standpoint  of  the  district  associations  and  that  of 
their  customers.  Of  course  this  limitation  does  not  rule 
out  paper  that  has  been  drawn  for  longer  periods.  The 
requirement  is  that  such  paper  must  be  within  sixty  days 


174  BANKING  PROGRESS 

of  maturity  before  the  district  associations  can  redis- 
count it. 

In  some  respects  the  pennission  granted  in  (b)  (3)  to 
discount  the  direct  obligations  of  quaUfying  institutions 
is  out  of  harmony  with  the  spirit  and  general  purpose 
of  this  act,  which  is  to  draw  a  sharp  line  of  distinction 
between  commercial  and  investment  banking,  and  to 
connect  the  issue  of  currency  with  the  former  and  to  dis- 
connect it  from  the  latter.  Under  very  strict  limitations 
this  section  permits  loans  on  investment,  instead  of  com- 
mercial, collateral,  and  thus  permits  the  issue  of  treasury 
notes  and  the  expansion  of  bank  credits  against  invest- 
ment securities. 

The  danger  of  this  provision  consists  in  the  fact  that 
it  leaves  open  a  door  of  escape  to  banks  that  violate  the 
principles  of  sound  commercial  banking.  But  in  times 
of  crises  it  would  be  difficult,  if  not  impossible,  to  refuse 
such  a  bank  the  privilege  described  in  this  section.  On 
the  other  hand,  investment  banking  is  not  only  perfectly 
legitimate,  but  just  as  necessary  as  commercial  banking, 
and  the  two  kinds  are  now,  and  are  bound  to  continue 
to  be,  carried  on  together  by  most  of  the  banks  and  trust 
companies  of  the  country.  It  is  possible  that  a  bank  or 
trust  company  whose  practices  had  been  conservative 
and  beyond  reproach,  might  find  itself,  as  a  result  of 
very  unusual  and  unexpected  combinations  of  circum- 
stances, in  need  of  more  cash  than  it  could  get  through 
the  rediscount  of  its  commercial  paper.  Should  such  a 
bank  be  denied  relief  by  its  district  association  .f*  It  is 
in  the  belief  that  it  should  not,  and  that  the  granting  of 
such  relief  under  the  limitations  here  imposed  would  not 
be  dangerous,  that  this  section  has  been  included. 

The  purpose  of  Section  10  is  to  provide  a  form  of  com- 
mercial bill  of  the  widest  possible  currency,  namely,  the 


.A  PROPOSED  BILL  175 

hanke/s  bill  already  in  such  general  use  on  European 
markets.  It  should  be  noted  that  the  bill  which  it  is 
the  purpose  of  this  section  to  create  is  not  a,  finance  bill 
(i.  e.,  a,  bill  drawn  not  against  a  shipment  of  goods  or 
securities,  but  being  in  itself  essentially  a  loan),  but  a 
commercial  bill  of  the  same  general  character  as  the  one 
described  in  Section  8.  Such  a  bill  would  have  to  be 
accompanied  by  the  same  kind  of  evidence  of  its  real 
commercial  character  as  the  acceptance  or  personal  note 
of  a  merchant  or  manufacturer.  Bills  of  this  character 
could  be  readily  negotiated  on  foreign  markets,  and  could 
be  used  by  the  treasury  board  in  replenishing  its  reserves 
in  case  of  need.  They  would  also  be  purchased  by  banks 
in  this  country  whose  loan  funds  were  in  excess  of  local 
needs  and  would  probably  take  the  place  of  bonds  in 
the  secondary  reserves  of  banks. 

Section  29,  given  later  in  the  bill  under  investments, 
simply  authorizes  the  district  associations  to  make  use 
of  idle  funds  in  case  a  suflBcient  amount  of  paper  does 
not  come  to  them  in  the  form  of  rediscounts.  In  other 
words,  it  is  permitted  to  solicit  as  well  as  to  accept  paper 
for  discount. 

The  subject  of  a  uniform  rate  of  discount  is  treated  in 
Section  11.  In  the  discussion  to  date,  objections  have 
been  made  to  a  rate  uniform  to  the  whole  country,  fixed 
by  a  central  agency  in  Washington,  on  the  ground  that 
in  our  big  country  there  are  great  differences  in  banking 
and  industrial  conditions,  and  in  the  local  supply  of 
capital,  consequently  causing  legitimate  differences  in 
the  rates  of  interest  in  different  sections.  Then,  too,  if 
one  rate  were  fixed  for  all  sections,  a  rate,  e.  g.,  current 
in  New  England,  would  encourage  expansion  in  a  distant 
Western  district,  and  draw  capital  away  from  legitimate 
uses  in  conservative  districts.    In  any  case,  however. 


176  BANKING  PROGRESS 

the  rate  in  this  bill  is  one  only  between  the  rediscounting 
district  association  and  its  member  banks.  It  does  not 
change  the  relations  between  the  individual  bank  and  its 
customer.  But  while  recognizing  that  general  differences 
in  levels  of  interest  may  exist  in  different  parts  of  the 
country,  and  that  each  district  association  may  fix  the 
rate  within  its  district  (subject  to  approval  by  the  treasury 
board),  this  rate  must  be  uniform  to  every  bank  within 
a  given  district.  Thus,  while  securing  equality  of  treat- 
ment for  all  banks,  big  or  little,  within  any  one  district, 
it  provides  a  suitable  flexibility  for  differing  conditions 
in  a  large  country  by  allowing  different  rates  in  different 
districts. 

§  6.  The  functions  of  the  treasury  board  are  given  in 
the  following  sections,  additional  to  Sections  1  to  11: 

Sec.  12.  The  Treasury  Board  shall  appoint  a  Board  of  Ex- 
aminers, consisting  of  three  members,  to  report  at  any  time 
upon  the  conditions  of  credit,  the  kind  of  business  done,  and 
the  proper  conduct  of  the  discounts  at  each  District  Associa- 
tion, or  of  any  individual  bank;  and  said  Treasury  Board  may 
authorize  the  employment  of  suitable  assistance,  if  needed, 
for  this  work  of  examination. 

Sec.  13.  To  assist  the  Treasury  Board  in  the  performance 
of  its  duties,  there  shall  be  established  an  Advisory  Board  to 
consist  of  representatives  of  the  District  Association,  one  such 
representative  to  be  appointed  by  the  Board  of  Directors  of 
each  Association,  and  ten  other  persons  to  be  selected  by  said 
representatives  from  a  list  of  twenty-one  nominees  named, 
seven  each  respectively  by  three  committees  representing  re- 
spectively the  leading  agricultural,  industrial  and  commercial 
organizations  of  the  United  States.  The  method  of  appoint- 
ing said  committees  shall  be  prescribed  from  time  to  time  by 
the  by-laws  of  the  Treasury  Board. 

The  Advisory  Board  shall  hold  regular  monthly  meetings 
and  special  meetings  whenever  called  by  the  Treasury  Board. 


A  PROPOSED  BILL  177 

Full  reports  of  the  operations  of  the  Treasury  Board  during  the 
preceding  month  shall  be  presented  by  its  manager,  and  any 
member  of  the  Advisory  Board  may  offer  criticisms  or  sugges- 
tions. The  final  decision  on  all  matters,  however,  shall  remain 
with  the  Treasury  Board. 

At  all  meetings  of  the  Advisory  Board,  a  quorum  shall  con- 
sist of  a  majority  of  all  members.  Each  member  shall  be  re- 
imbursed for  his  reasonable  travelling  and  other  necessary  ex- 
penses for  attendance  at  each  meeting  on  vouchers  approved 
by  the  Treasury  Board. 

Sec.  14.  Said  Treasury  Board  shall  establish  an  oflBce  with 
each  District  Association,  under  charge  of  its  own  oflBcial,  in 
which  may  be  held  such  papers,  securities.  Treasury  notes,  or 
cash  of  any  sort,  the  property  of  said  Treasury  Board,  as  may 
be  deemed  expedient  in  connection  with  daily  transactions,  or 
with  any  transfer  of  funds  from  one  District  Association  to 
another,  or  in  the  redemption  of  its  Treasury  notes. 

Sec.  15.  The  expenses  of  the  Treasury  Board  shall  be  paid 
by  the  District  Associations  out  of  their  gross  receipts  in  such 
a  manner  and  at  such  times  as  the  Treasury  Board  shall  direct. 
Each  Association  shall  pay  such  a  portion  of  said  expenses  as 
its  capital  and  surplus  bear  to  the  aggregate  capital  and  sur- 
plus of  all  the  Associations. 

The  board  established  in  Section  1  is  assigned,  in  sub- 
sequent sections,  administrative  and  supervisory  func- 
tions only,  and  hence  needs  no  capital.  The  period  of 
its  corporate  existence  is  made  twenty  years  to  corre- 
spond with  that  of  the  district  associations  described  in 
Section  2.  This  period  is  long  enough  to  give  the  insti- 
tution a  fair  trial  and  not  so  long  as  to  commit  the 
country  unduly  to  an  untried  experiment.  It  should  be 
observed  that  no  legislation  is  required  to  continue  its 
existence  beyond  this  period.  It  is  possible  that  the 
right  to  revise  the  charter  more  frequently  than  once  in 
twenty  years  should  be  reserved.  The  Canadian  banking 
act  may  be  amended  by  Parliament  every  ten  years. 

The  name,  j:reasury  board,  is  not  inappropriate  inas- 


178  BANKING  PROGRESS 

much  as  the  secretary"  of  the  treasury  and  the  comptroller 
of  the  currency  are  the  ex  officio,  and  thus  the  only  per- 
manent, members  of  it,  and  inasmuch  as  four  other  mem- 
bers are  to  be  named  by  the  President.  This  name  has 
the  advantage  of  suggesting  the  connection  of  the  gov- 
ernment with  it,  and  thus  of  inspiring  public  confidence 
in  the  notes  it  is  authorized  to  issue. 

In  Section  11  the  treasury  board  is  given  supreme  au- 
thority over  rates  of  discount,  but  at  the  same  time  an 
initiative  in  their  determination  is  granted  to  the  district 
associations.  Should  circumstances  seem  to  demand, 
it  is  possible  under  the  operations  of  this  section  that 
different  rates  might  prevail  in  different  sections,  but  at 
the  same  time  this  condition  of  things  could  be  pre- 
vented or  modified  at  will  by  the  treasury  board.  This 
arrangement  is  probably  safest  for  us  under  present  con- 
ditions. Since  the  district  associations  are  to  do  the  dis- 
counting, under  ordinary  circumstances  they  will  be  in 
closest  touch  with  the  market  and  best  fitted  to  fix  rates 
in  their  respective  districts.  On  the  other  hand,  the 
treasury'  board  will  alone  be  in  possession  of  all  the  data 
relative  to  the  state  of  the  gold  reserves  and  the  conditions 
of  credit  throughout  the  country  as  a  whole,  and  should, 
therefore,  have  the  power  to  order  such  changes  in  rates 
as  these  conditions  demand.  If  uniform  rates  through- 
out the  country  prove  to  be  feasible  and  desirable  the 
treasury  board  can  establish  them.  On  the  other  hand, 
if  such  uniformity  should  threaten  overexpansion  in  cer- 
tain sections,  and  the  undue  concentration  of  the  bank- 
ing resources  of  the  country  there,  the  power  to  prevent 
it  rests  likewise  with  the  treasury  board. 

As  defined  by  this  bill,  it  is  the  function  of  the  treasury 
board  to  act  as  an  instrument  of  control  and  co-operation 


A  PROPOSED  BILL  179 

for  the  district  associations.  The  board  of  examiners 
provided  for  in  Section  12  is  an  important  and  essential 
part  of  the  machinery  for  these  purposes.  The  treasury 
board  must  have  direct  access  at  all  times  to  the  books  of 
the  district  associations  and  be  in  constant  touch  with 
them.  For  these  purposes  written  reports  made  to  the 
board  by  these  associations  are,  of  course,  necessary,  but 
inadequate.  An  examining  board  such  as  is  here  pro- 
vided would  be  the  strong  arm  of  the  treasury  board  in 
the  most  essential  features  of  its  work. 

The  treasury  board  (Section  15)  will  have  no  inde- 
pendent source  of  income.  The  commercial  paper,  ac- 
ceptances, and  bonds  transferred  to  it,  as  well  as  the  gold 
and  other  forms  of  money,  will  remain  the  property  of 
the  district  associations  making  such  transfers,  and  the 
interest  earned  on  them  will  be  theirs.  In  all  of  its 
operations  the  treasury  board  will  be  simply  their  agent, 
and  its  expenses  will  therefore  be  properly  chargeable  to 
them. 

In  brief  the  functions  of  the  treasury  board  may  be 
summarized  as  follows: 

1.  To  supervise  as  a  body  of  experts  the  operations  of  the 
District  Associations  while  leaving  all  direct  discounting  to  the 
Associations;  in  fact,  to  represent  the  United  States  as  a  super- 
vising body  over  banking  and  currency. 

2.  To  advise  against  inflation  or  speculation  in  any  one 
District,  should  it  arise,  and  to  have  power  for  that  purpose 
over  the  rate  of  discount. 

3.  To  have  the  power  to  examine  into  the  conduct  of  any 
District  Association,  or  of  any  individual  bank. 

4.  To  act  as  an  issue-agency  for  all  the  District  Associations 
in  common,  and  to  hold  and  account  for  the  protection  behind 
the  Treasury  notes. 

5.  To  act  iu  the  transition  period  as  the  agent  for  refunding 


180  BANKING  PROGRESS 

the  2  per  cent  United  States  bond  (with  the  circulation  priv- 
ilege) into  3  per  cents  (without  the  circulation  privilege)  and 
the  gradual  change  of  bonds  into  gold  behind  the  Treasury 
notes. 

6.  To  bring  about  the  substitution  of  Treasury  notes  for  all 
national  bank  notes. 

7.  To  publish  combined  dnd  separate  accounts  for  all  Dis- 
trict Associations  once  a  week,  and  also  weekly  statements  of 
the  issue  of  Treasury  notes  and  the  assets  behind  them. 

8.  To  watch  over  the  gold  reserves  through  the  agencies  of 
the  District  Associations,  or  to  import  gold,  if  needed. 

In  order  to  obtain  the  guidance  and  experience  of  men 
representing  all  parts  of  the  country,  an  advisory  board 
has  been  created  to  work  with  the  treasury  board.  Local 
or  sectional  points  of  view  will  be  mingled  in  the  inter- 
ests of  the  country  as  a  whole  through  this  agency. 
Moreover,  there  will  be  better  opportunity  to  compare 
conditions  of  business  and  credit  in  all  parts  of  the 
United  States;  and  to  receive  advice  as  to  making  pos- 
sible changes  in  the  rate  of  discount. 

§  7.  The  district  associations  provided  for  in  Sec- 
tions 2-7  constitute  the  characteristic  features  of  the 
plan  upon  which  this  act  has  been  constructed,  namely, 
that  of  the  estabHshment  of  a  number  of  regional  banks, 
which,  through  the  treasury  board,  will  co-operate  in 
matters  of  national  import,  such  as  the  issue  of  notes, 
the  administration  of  specie  reserves,  and  the  retirement 
of  the  national  bank  and  the  United  States  notes.  Each 
regional  bank  will  serve  as  a  rediscount  and  reserve 
centre  for  the  banks  and  trust  companies  of  its  district, 
and,  through  its  connection  with  the  treasury  board,  will 
make  these  banks  and  trust  companies  parts  of  a  national 
organization  through  which  our  currency  and  credit 
system  may  be  properly  regulated  and  controlled.    The 


A  PROPOSED  BILL 


181 


relation  of  the  district  associations  to  the  treasury  board 
may  be  best  expressed  by  the  accompanying  diagram: 


& 


A  =  Treasury  board,  or  the  agency  of  B,  B,  etc.  An  agency  for  issuing  notes, 
holding  protection  behind  notes,  having  no  capital,  having  general  supervisory 
powers  over  rate  of  discounts,  etc.,  and  under  close  government  supervision. 

B,  B,  B,  etc.  =  District  associations,  rediscounting  agencies  for  the  indi- 
vidual banks,  C,  C,  C,  etc. 

D,  D,  Z)  =  Reserves  of  B,  which  might  be  the  notes  of  the  treasury  board  A. 
The  reserves  of  C,  C,  C  should  not  be  treasury  board  notes,  but  gold  or  lawful 
money.  This  rule  would  force  treasury  notes  back  for  redemption  when  not 
needed  by  the  public. 

A,  A,  etc.  =  Offices  of  A  at  each  district  association,  where  notes  would  be 
redeemed,  or  commercial  paper  exchanged  for  notes. 

The  bill  provides  for  the  performance  of  the  chief  func- 
tions usually  possessed  by  a  central  bank  through  local 
institutions  centrally  supervised  and  controlled  in  so  far 
as  the  proper  functioning  of  our  national  currency  and 
credit  system  requires  such  supervision  and  control. 
The  capital  of  these  associations  should  be  proportional 
to  the  amount  of  business  they  are  likely  to  be  called 
upon  to  perform.  Liasmuch  as  they  will  have  as  working 
funds,  in  addition  to  the  amounts  paid  in  by  stockhold- 
ers, the  reserves  deposited  with  them  and  the  proceeds 
of  collections,  and  inasmuch  as  the  proceeds  of  redis- 
counts will,  to  a  considerable  extent,  be  left  on  deposit  to 
be  used  for  clearing  and  transfer  purposes,  it  seems  prob- 
able that  a  capital  stock  equal  to  10  per  cent  of  the  cap- 
ital and  surplus  of  the  banks  and  trust  companies  of  the 
district  will  be  entirely  adequate. 


182  BANKING  PROGRESS 

The  size  of  the  districts  must  be  determined  chiefly 
by  the  convenience  of  banks  and  this  will  depend  to  a 
considerable  extent  upon  facilities  for  transportation. 
It  seems  clear,  however,  that  no  district  should  be  so 
small  as  to  be  unable  to  supply  the  association  with  a 
capital  of  at  least  $10,000,000.  Probably  most  of  the 
districts  would  be  much  larger  than  this,  and  in  some 
cases  it  will  probably  be  necessary  to  have  several  redis- 
count offices  under  the  supervision  and  control  of  one 
district  association.  Inasmuch  as  it  is  wise  to  start  with 
a  small  number  of  associations  so  that  each  would  com- 
mand respect  for  stability  and  resources,  and  inasmuch 
as  one  of  these  would  cover  a  considerable  geographical 
area,  there  woiild  be  additional  reasons  for  establishing 
agencies  of  an  association  within  any  one  district  for 
convenient  operation  of  its  business. 

The  separate  incorporation  of  each  district  associa- 
tion (Section  6)  will  be  necessary  since  each  is  to  be  an 
independent  organization  with  a  capital  of  its  own  feder- 
ated with  other  independent  organizations  of  the  same 
kind.  It  should  be  noted  that  among  its  corporate  powers 
is  that  of  acting  as  a  clearing  institution.  The  manner 
in  which  this  function  is  to  be  performed  is  described  in 
a  subsequent  section. 

In  the  plan  here  suggested  (in  Section  7)  for  the  choice 
of  the  directorates  of  the  district  associations,  three  de- 
siderata have  been  held  in  mind,  namely,  efficiency,  demo- 
cratic control,  and  proper  connection  with  the  treasury 
board.  In  order  to  be  efficient,  these  boards  must  con- 
sist of  men  who  know  intimately  the  agriculture,  com- 
merce, and  industry  of  the  section.  The  bankers  are  best 
fitted  to  select  such  men,  since  they  alone  know  them  all 
and  know  them  intimately,  especially  in  their  financial 
relations,  which  are  here  most  important.    It  is  for  this 


A  PROPOSED  BILL  183 

reason  and  because  other  practicable  methods  did  not 
suggest  themselves  that  the  actual  selection  of  some  and 
the  nomination  of  all  the  directors  is  put  into  the  hands 
of  organized  banks  and  clearing-houses. 

Democratic  control  is  secured,  firstly,  by  providing  for 
representation  of  all  the  interests  concerned,  the  local 
banks  whose  paper  is  to  be  discounted  and  whose  reserves 
are  to  be  administered,  the  clearing-house  of  the  city  in 
which  the  main  oflSce  of  the  association  is  located  (which 
is  interested  in  the  same  way  that  other  banks  are,  and 
additionally  because  the  association  is  to  conduct  inter- 
municipal  clearings),  the  farmers,  merchants,  and  manu- 
facturers of  the  district  who  must  use  the  banks  and  trust 
companies  in  the  every-day  conduct  of  their  affairs,  and 
the  treasury  board,  which  represents  the  government 
and  the  people  as  a  whole  and  has  general  controlling 
and  supervising  powers  over  all  the  associations.  Sec- 
ondly, no  one  of  these  groups  of  interests  is  given  con- 
trol of  the  institutions;  no  action  can  be  taken  without 
agreement  between  at  least  two  of  them;  and,  thirdly, 
absolute  equality  between  the  voting  institutions  is  se- 
cured, the  number  of  banks  and  trust  companies  in  each 
voting  group  having  equal  power,  and  each  bank  and 
trust  company  within  each  group  being  given  the  same 
voting  rights  and  privileges  regardless  of  its  size.  In 
such  an  organization  big  banks  could  have  no  advantage 
over  little  ones,  and  no  kind  of  coercion  could  be  exerted. 

The  treasury  board  cannot  perform  its  functions  un- 
less there  is  complete  harmony  of  action  and  policy  be- 
tween it  and  the  district  associations.  This  is  here  se- 
cured by  giving  said  board  the  power  to  choose  as  directors 
five  representatives  of  the  agriculture,  commerce,  and  in- 
dustry of  the  section  from  a  list  of  fifteen  candidates  se- 
lected by  the  other  directors.     If  it  is  thought  best  to 


184  BANKING  PROGRESS 

increase  the  power  of  the  treasury  board,  a  further  pro- 
vision might  be  added  to  the  effect  that  ia  case  five  per- 
sons satisfactory  to  said  board  could  not  be  found  among 
the  fifteen  first  nominated,  other  nominations  must  be 
made  until  a  suflScient  number  of  satisfactory  persons 
are  found. 

The  examining  boards  provided  (in  Section  7)  will  con- 
stitute a  very  important  part  of  the  machinery  of  the 
district  associations.  Their  chief  functions  will  be  to 
aid  in  the  selection  of  the  paper  offered  for  rediscount 
and  in  securing  the  enforcement  on  the  banks  and  trust 
companies  of  the  country  of  the  regulation  and  practices 
prescribed  by  this  act  and  involved  in  its  operations. 
Banks  will  also  need  support  and  assistance  in  the  proc- 
ess of  putting  their  business  on  a  commercial  paper  basis, 
and  these  examining  boards  should  be  of  great  assistance 
in  this  direction.  The  efficiency  of  such  boards  has  been 
demonstrated  by  the  clearing-house  associations  of  our 
large  cities,  and  there  is  no  good  reason  for  believing  that 
boards  here  provided  for  would  not  be  equally  efficient. 

§  8.  In  regard  to  note-issues  this  bUl  went  further 
than  poKtical  opinion  in  Congress  was  likely  to  go. 
Nevertheless,  European  experience  has  pointed  out 
methods  by  which  we  might  have  provided  an  ideal  sys- 
tem of  our  own.  Consequently,  the  provisions  of  the 
bill  on  this  subject  are  in  advance  of  what  might  be  politi- 
cally possible.    The  sections  on  note-issues  are  as  follows: 

Sec.  16.  At  the  office  of  the  Treasury  Board  in  Washing- 
ton shall  be  established  an  Issue  Department,  and  the  accounts 
of  the  Issue  Department  shall  be  separately  kept  and  so  pub- 
lished weekly. 

Sec.  17.  To  the  Department  of  Issue  of  the  Treasury 
Board  shall  be  transferred  by  the  District  Associations  all  the 


' 


A  PROPOSED  BILL  185 

United  States  notes  and  national  bank  notes  paid  in  for  capital 
stock,  or  received  on  deposit  by  the  District  Associations  from 
any  source;  and,  also,  all  gold  coin  and  gold  certificates  re- 
ceived by  the  District  Associations  which  are  not  retained  for 
their  daily  demands.  In  return,  said  Department  of  Issue 
shall  issue  to  the  respective  District  Associations  a  like  amount 
of  the  notes  of  the  Treasury  Board  in  denominations  to  be  fixed 
by  said  Treasury  Board,  and  designated  "Treasury  Notes,"  or  at 
the  option  of  said  Association  credit  the  amount  to  its  account. 

The  Treasury  of  the  United  States  shall  likewise  transfer  to 
the  Treasury  Board  in  exchange  for  Treasury  notes  all  the 
United  States  notes  and  national  bank  notes  that  come  into 
its  possession. 

The  United  States  notes  and  national  bank  notes  thus  re- 
ceived by  said  Department  of  Issue  shall  not  be  paid  out  again, 
but  shall  be  held  until  disposed  of  in  the  manner  hereinafter 
indicated. 

Sec.  18.  The  national  bank  notes  received  by  the  Issue 
Department  of  the  Treasury  Board  shall  be  debited  in  a  special 
account  to  the  banks  which  issued  them  and  the  amounts  thus 
debited  shall  from  time  to  time  be  certified  to  the  District  Asso- 
ciations with  which  such  banks  do  business.  Whenever  any 
District  Association  has  received  from  such  a  bank  United 
States  bonds  to  secure  circulation  in  accordance  with  the  pro- 
visions of  Section  23  of  this  act,  it  shall  transfer  to  the  Treasury 
Board  an  amount  of  such  bonds  equal  to  the  notes  debited  as 
above  indicated  to  the  account  of  that  bank  on  the  books  of 
the  Issue  Department  of  the  Treasury  Board,  and  said  bonds 
when  so  received  shall  be  credited  at  par  to  the  note  account 
of  said  bank,  and  the  notes  of  said  bank  in  like  amount  be  can- 
celled and  destroyed. 

Sec.  19.  The  Treasury  Board  may  also  receive  for  the 
Issue  Department  from  District  Associations  selected  com- 
mercial paper  of  the  kind  previously  described  (Section  8) 
which  has  not  more  than  thirty  days  to  run,  in  amounts  re- 
ceived from  the  several  District  Associations  in  proportion  to 
the  needs  and  condition  of  business  of  each  District,  as  ad- 
judged by  said  Treasury  Board,  and  said  Issue  Department 
shall  issue  to  the  respective  District  Associations  in  return  an 
amount  of  its  Treasury  notes  equal  to  95  per  cent  of  the  value 


186  BANKING  PROGRESS 

of  said  commercial  paper,  Provided  that  at  all  times  the  amount 
of  gold  certificates,  gold  coin,  or  gold  bullion  in  the  reserves  of 
said  Issue  Department  shall  not  be  less  than  one-tiiird  of  the 
total  Treasury  notes  issued,  and  Provided  that  the  amount  of 
commercial  paper  thus  received  from  any  one  District  Asso- 
ciation shall  not  exceed  t^^Tice  the  amount  of  its  capital  and 
surplus. 

Sec,  20.  The  notes  of  said  Treasury  Board  shall  be  redeem- 
able on  demand  in  gold  coin,  or  gold  certificates,  at  the  option 
of  the  holder  at  its  office  in  Washington  or  in  its  oflBce  at  any 
District  iVssociation. 

All  notes  redeemed  by  the  Department  of  Issue  shall  be  can- 
celled and  not  reissued. 

To  pro\ade  the  means  for  redemption  in  gold,  the  Treasury 
Board  may  exchange  its  Treasury  notes  for  any  gold  coin, 
gold  certificates,  or  gold  bullion  in  the  hands  of  the  District 
Associations;  or  it  may  present  any  United  States  notes  in  its 
reserves  to  the  Treasuiy  of  the  United  States,  which  shall  give 
gold  in  redemption  of  said  notes.  Provided,  however,  that  the 
Treasurer  of  the  United  States  shall  not  pay  out  the  notes  thus 
redeemed  except  to  the  said  Treasury  Board  in  exchange  for 
gold  coin,  or  gold  certificates,  which  exchange  shall  be  made  at 
the  option  of  the  said  Treasury  Board  as  soon  as  its  gold  hold- 
ings shall  warrant  such  exchange;  or,  it  may  offer  any  of  the 
United  States  bonds  held  by  it,  not  having  the  circulation 
privilege,  under  the  refunding  clause  hereinafter  described 
(Section  24),  for  sale  for  gold,  or  it  may  use  them  as  a  basis 
for  a  loan  of  gold,  upon  such  terms  as  may  be  agreed  upon 
jointly  by  the  Executive  Committee  of  said  Treasury  Board 
and  the  Secretary  of  the  Treasury;  or,  it  may  receive  from  the 
District  Associations  in  return  for  its  Treasury  notes,  the  pro- 
ceeds in  gold  arising  from  the  discount  or  hypothecation  by 
the  District  Associations  of  any  gold  exchange,  or  any  bills  of 
exchange,  in  the  hands  of  said  District  Associations;  or,  it 
may  purchase  in  exchange  for  treasury  notes  from  District 
Associations  foreign  bills  of  exchange;  and  it  may  sell  in  foreign 
markets  for  gold  any  of  said  bills  of  exchange,  or  any  of  the 
commercial  paper  or  acceptances  in  its  possession. 

Sec.  21.  The  circulating  notes  of  the  Treasury  Board  shall 
be  received  at  par  in  payment  of  all  taxes,  excises,  and  other 
dues  to  the  United  States,  and  for  all  salaries  and  other  debts 


A  PROPOSED  BILL  187 

and  demands  owing  by  the  United  States  to  individuals,  firms, 
corporations,  or  associations,  except  obligations  of  the  Gov- 
ernment which  are  by  their  terms  specifically  payable  in  gold, 
and  for  all  debts  due  from  or  by  one  bank  or  trust  company  to 
another,  and  for  all  obligations  due  to  any  bank  or  trust  company. 
Sec.  22.  In  addition  to  the  cash  reserves,  the  United  States 
bonds,  and  the  commercial  paper  held  by  the  Issue  Depart- 
ment of  the  Treasury  Board,  held  as  security  for  the  rederap)- 
tion  of  said  Treasury  notes,  the  aforesaid  Treasury  notes  emitted 
by  said  Issue  Department  shall  be  a  first  lien  on  all  the  assets 
of  the  several  District  Associations  in  the  proportion  that  the 
capital  stock  of  any  one  District  Association  bears  to  the  total 
capital  stock  of  all  the  associations. 

In  explanation  of  the  plan  of  note-issues  thus  pre- 
sented, various  considerations  should  be  kept  in  mind. 

Elasticity  in  our  hand-to-hand  currency  is  one  of  the 
chief  objects  to  be  attained  through  the  treasury  board. 
Contraction  as  well  as  expansion  is  an  essential  of  elas- 
ticity. A  part  of  the  machinery  for  that  purpose  is  pro- 
vided in  Section  20.  The  redemption  of  the  treasury 
notes  in  gold  is  not  only  a  means  of  maintaining  their 
constant  parity  with  gold  coin,  but  of  reducing  the  volume 
of  the  currency  in  case  it  exceeds  the  needs  of  commerce. 
^Gold  is  a  commodity  useful  in  the  arts  as  well  as  in  the 
medium  of  exchange,  and  the  presentation  of  treasury 
notes  for  gold  and  the  use  of  the  gold  thus  obtained  for 
•non-monetary  purposes  or  for  hoarding  would  reduce  the 
volume  of  the  circulating  medium. 

Another  and  still  more  efficient  means  to  the  same  end 
is  the  withdrawal  at  maturity  by  the  district  associations 
of  the  commercial  paper  transferred  to  the  treasury 
board  (see  Section  19).  In  case  the  circulating  medium 
became  excessive,  such  withdrawals  would  exceed  in 
amount  the  current  transfers  of  commercial  paper  to 
the  treasury  board  in  exchange  for  notes,  and  the  only 
means  of  meeting  this  excess  would  be  the  transfer  to 


188  BANKING  PROGRESS 

the  treasury  board  of  an  equivalent  amount  of  the 
treasury  notes  or  of  legal-tender  money  withdrawn  from 
circulation.  The  treasury  notes,  when  withdrawn,  would 
be  cancelled  and  destroyed,  and  the  legal-tender  money 
held  in  reserve. 

At  this  point  the  question  may  be  raised  (Section  21) 
whether  the  treasury  notes  should  be  made  legal  tender 
for  all  purposes  except  payments  by  the  treasury  board 
and  the  district  associations.  There  seems  to  be  no  good 
reason  for  giving  them  this  quality.  Being  redeemable 
in  gold  on  demand,  they  will  circulate  readily  without 
being  legal  tender,  and  it  is  desirable  to  encourage  in 
every  way  their  presentation  for  redemption  whenever 
there  is  the  least  redundancy;  and  depriving  them  of  the 
legal-tender  quality  to  some  extent  at  least  offers  such 
encouragement. 

The  security  of  the  treasury  notes  issued  under  the  au- 
thority of  this  act  will  be  beyond  question  (Sections  19- 
22).  They  will  be  completely  covered  by  gold  and  other 
forms  of  legal-tender  money,  by  United  States  bonds, 
and  by  short-time  commercial  paper  which  has  passed 
the  scrutiny  of  both  district  associations  and  the  treasury 
board,  and  which  bear  the  indorsement  of  the  institu- 
tions which  presented  them  for  rediscount.  Losses  on 
such  paper,  if  any  should  occur,  would  fall  upon  the  dis- 
trict association  which  deposited  it  with  the  treasury 
board  as  security  for  notes  issued.  It  is  not  possible 
that  such  losses  would  be  large  enough  to  affect  appre- 
ciably the  resources  of  any  association.  The  first  lien 
on  assets  here  provided  for  is  probably  unnecessary,  but 
it  will  put  beyond  question  the  public  confidence  in  the 
safety  of  the  notes.  In  the  end,  with  the  gradual  dis- 
posal of  United  States  notes  and  bonds,  the  protection 
to  the  notes  would  tend  to  become  more  largely  gold  and 
commercial  paper. 


A  PROPOSED  BILL  189 

Section  19  provides  for  a  minimum  gold  reserve  of 
one-third  against  note-issues.  All  issues  not  covered  by 
gold  would  be  covered  by  the  special  reserves  of  green- 
backs and  national  bank  notes  held  by  the  treasury 
board  pending  their  retirement,  by  bonds  acquired  in 
the  manner  indicated  in  the  preceding  section,  and  by 
commercial  paper  maturing  in  sixty  days  or  less.  The 
treasury  board  could  enlarge  its  gold  reserve  at  any  time 
by  selling  its  bond  holdings,  by  transferring  greenbacks 
to  the  treasury  for  redemption,  by  selling  abroad  such 
of  its  commercial  paper  as  might  be  there  negotiable,  by 
collecting  its  foreign  bills  at  maturity  or  rediscounting 
them  on  foreign  markets,  or  by  borrowing  gold  on  the 
security  of  its  bonds. 

The  transfer  of  commercial  paper  to  the  treasury  board 
as  herein  provided  would  constitute  the  principal  means 
in  the  possession  of  the  district  associations  of  replenish- 
ing their  cash  resources.  Another  means  would  be  the 
presentation  to  the  treasury  board  of  treasury  notes  for 
redemption  in  gold,  and  a  third  would  be  the  deposits  of 
cash  made  with  the  associations. 

Maintaining  one  reserve  for  both  demand-liabilities — 
notes  and  deposits — was  the  characteristic  of  early  bank- 
ing in  the  United  States  when  checks  drawn  on  deposits 
were  much  less  used  than  bank-notes.  The  two  United 
States  Banks  were  types  of  this  kind,  as  were  also  the 
banks  under  State  charters  before  1838.  Such  a  type  of 
bank  reflected  the  rural  conditions  of  the  time  and  the 
habit  of  using  chiefly  notes  or  coin  as  a  medium  of  ex- 
change. After  the  New  York  Free  Banking  Act  of  1838, 
separate  assets  were  pledged  for  the  notes.  This  plan  was 
improved  upon  and  adopted  into  our  national  banking  sys- 
tem; but  notes  secured  by  United  States  bonds,  while 
safe,  proved  wholly  inelastic.  The  Bank  of  France  is  of 
the  same  type  as  were  the  two  United  States  Banks  of 


190  BANKING  PROGRESS 

our  early  history,  having  but  one  reserve  for  both  notes 
and  deposits;  and  for  the  very  good  reason  that  in  France 
notes,  not  checks  drawn  on  deposits,  form  the  chief 
medium  of  exchange.  Much  the  same  is  true  of  the 
Reichsbank. 

The  development  of  our  own  banking  habits  and  the 
characteristics  of  our  business  methods  require  a  system 
different  from  that  of  these  Continental  banks.  If  any 
European  example  may  suggest  methods  to  us,  it  would 
be  that  of  Great  Britain,  which  is  the  only  other  country 
that  has  a  fully  developed  credit  system  like  our  own; 
it  is  the  only  other  country  that  uses  chiefly  the  deposit- 
currency,  instead  of  notes,  as  a  medium  of  exchange. 
The  problem  in  the  United  States  is  much  more  the  or- 
ganization of  credit  through  the  elasticity  of  lending 
power  (carried  out  by  using  checks  drawn  on  deposits 
which  arise  from  loans)  rather  than  the  mere  elasticity  of 
notes — although  the  two  are  intimately  connected  to- 
gether. Hence,  the  wisdom  of  so  separating  the  func- 
tions of  issue  and  discount  that,  while  their  interde- 
pendence is  clearly  accepted,  their  distinct  operation 
may  be  seen  and  their  dangers  and  merits  made  entirely 
public.  The  silent  education  which  will  come  from  the 
separate  publication  of  the  issue  and  discount  statements 
is  not  the  least  of  the  advantages  of  this  provision. 

In  Sections  16-20  it  is  intended  to  transfer  the  note- 
issuing  function  from  the  existing  national  banks  to  an 
issue  department  in  the  treasury  board. 

It  is  assumed  that  bond-secured  notes  are  so  inelastic 
and  undesirable  that  they  will  not  be  continued.  In 
place  of  bonds,  what  security  shall  be  provided?  There 
are  in  the  main  the  following  alternatives: 

(1)  Substitute  the  general  assets  of  a  bank  for  bonds  and 
leave  issues,  as  now,  to  the  national  banks. 

(2)  Allow  bonds,  securities,  etc.,  other  than  United  States 


A  PROPOSED  BILL  191 

bonds,  as  security,  as  is  provided  by  the  Aldrich-Vreeland  Act 
in  eflfect  through  currency  associations;  and  still  leave  issues 
to  the  individual  national  banks. 

(3)  Take  away  the  issues  from  the  national  banks  and  en- 
trust them  to  some  agency  acting  for  all  the  banks,  and  secure 
the  notes  by  cash  reserves,  some  United  States  bonds,  and  a 
flexible  amount  of  selected  commercial  paper,  sent  in  by  Dis- 
trict Associations. 

■  (4)  Retain  existing  national  bank  notes,  but  allow  in  addi- 
tion District  Associations  to  issue  notes  based  on  deposit  of 
bonds  or  commercial  paper. 

(5)  Substitute  Government  issues  for  national  bank  notes. 
These  notes  to  be  the  promises  to  pay  of  the  United  States, 
but  transferred  by  the  Treasury  to  District  Associations  when 
needed  by  them  in  rediscounting  for  individual  banks. 

(1)  To  allow  a  national  bank  to  use  any  of  its  existing 
assets  as  a  basis  for  note-issues  implies  a  trustfulness  in 
the  character  of  the  paper  held  in  every  bank,  in  any 
part  of  the  country,  which  is  not  warranted.  Such  a 
plan  would  result  in  notes  as  varied  in  soundness  as  the 
managements  of  the  different  banks.  Even  if  the  notes 
were  limited  to  a  percentage  of  the  bank's  capital,  this 
objection  would  still  hold.  To  take  away  the  security 
of  United  States  bonds  is  to  remove  the  very  element 
which  gives  uniformity  of  value  to  the  national  bank 
notes  in  all  parts  of  the  country;  and  we  thereby  retro- 
grade to  the  faulty  protection  of  most  State  bank  notes 
from  1838  to  1864. 

Moreover,  the  permission  to  each  national  bank  to 
issue  notes  based  on  its  general  assets,  without  close 
supervision  over  them,  would  lend  itself  to  undue  expan- 
sion, even  if  there  were  a  restriction  to  some  percentage 
of  issues  to  capital.  If  such  issues  were  safe,  there  should 
be  no  restriction  on  the  amount  of  notes  except  the  needs 
of  the  public  (subject  to  contraction  arising  from  im- 
mediate redemption  in  gold).     So  long  as  our  present 


192  BANKING  PROGRESS 

reserve  system  continues,  the  danger  would  exist  that  a 
surplus  of  bank-notes  would  remain  in  circulation,  in- 
stead of  being  redeemed  and  retired,  while  a  correspond- 
ing amount  of  legal  tenders  would  be  forced  into  bank 
reserves  as  hoards.  Once  reserve  funds  were  thus  in- 
creased, expansion  would  be  almost  certain  to  follow. 

Further,  the  State  banks  ought  to  be  treated  equally 
with  national  banks  as  regards  issues  as  well  as  discounts. 
The  withdrawal  of  the  issues  from  individual  banks,  and 
their  assumption  by  a  single  agency  in  behalf  of  all  the 
banks,  would  be  a  protection  against  ill-advised  action 
by  any  individual  bank,  and  yet  secure  equality  of  treat- 
ment to  State  as  well  as  to  national  banks. 

(2)  The  loose  provisions  of  the  Aldrich-Vreeland  Act 
allow  any  kind  of  securities,  such  as  railway  or  other 
bonds,  and  any  kind  of  paper  held  by  national  banks,  as 
protection  to  the  emergency  notes  issued  through  cur- 
rency associations.  But,  in  addition,  the  tax  on  these 
notes  is  so  high  that  the  rate  charged  to  the  borrower  by 
a  bank  must  be  the  result  of  panic  conditions  before  they 
would  possibly  be  asked  for.  With  such  a  tax  no  resort 
is  likely  to  be  made  to  this  act.  Already  the  rate  of  in- 
terest (1912)  has  risen  from  12  to  20  per  cent  and  no  ap- 
peal has  been  made  to  the  law. 

(3)  The  currency  problem  is  one  not  merely  of  the 
issue  of  notes;  it  is  closely  connected  with  the  organiza- 
tion of  credit.  To  get  a  loan,  with  a  consequent  deposit- 
account  on  which  checks  can  be  drawn,  is  as  effective  a 
means  of  paying  debts,  according  to  the  business  and 
banking  habits  of  this  country,  as  the  actual  passage  of 
bank-notes.  Either  notes  or  checking  accounts  should  be 
equally  available  to  the  legitimate  borrower,  according 
to  his  needs,  and  the  habits  of  our  people.  The  elas- 
ticity of  the  two  must  go  together.  From  whatever 
angle  we  approach  the  subject  of  banking,  it  will  always 


A  PROPOSED  BILL  193 

be  found  that  soundness  depends  upon  the  kind  of  paper 
discounted.  To  secure  soundness  of  discounts  is  the 
only  real  guaranty  of  safety  to  deposits. 

Hence,  apart  from  carefully  guarding  the  paper  re- 
discounted  bj^  the  district  associations,  we  must  face  the 
question  of  the  security  of  note-issues,  which  pass  into  the 
hands  of  innocent  holders  and  whose  safety  must  be 
beyond  question.  To  avoid  the  danger  of  the  varying 
character  of  notes,  due  to  the  varying  soundness  of  assets 
in  banks  of  all  kinds,  the  obvious  remedy  is  the  selection 
of  one  agency  which  should  issue  the  notes  needed  by  all 
the  banks.  The  security  of  the  notes  issued  by  one  agency 
would  be  so  under  the  limelight  that  anything  but  safety 
would  be  impossible.  Simplicity  of  issues,  understood 
by  all,  would  be  a  great  advantage.  If  the  supervising 
body  over  the  district  associations  be  chosen  as  the 
issuing  agency,  little  machinery  and  no  capital  would 
be  needed.  Moreover,  the  notes  would  be  the  obliga- 
tions of  the  combined  district  associations,  but  having  a 
flexible  margin  of  commercial  paper  which  would  make 
them  entirely  elastic,  as  well  as  entirely  safe.  Being  re- 
deemable in  gold  at  any  district  association,  they  could 
not  circulate  in  amount  beyond  the  currency  needs  of 
the  public.  The  important  consideration  to  be  borne  in 
mind  is  that  the  safety  and  redemption  of  the  notes  are 
placed  on  the  banks,  without  any  cost  for  reserves  to  the 
United  States.  This  agency,  under  the  close  supervision 
of  the  government,  secures  all  the  advantages  of  govern- 
ment issues,  without  any  expense  or  inelasticity.  And 
if  there  is  anything  in  the  claim  that  the  national  banks 
gain  a  double  profit  by  issuing  notes  based  on  United 
States  bonds,  it  is  clear  that  this  is  taken  away,  and  all 
the  profits,  both  of  issue  and  discount  (beyond  5  per 
cent  on  capital),  go  to  the  United  States. 

The  accounts  of  each  district  association  would  con- 


194 


BANKING  PROGRESS 


tain  the  same  items,  and  their  combined  figures  reported 
to  the  treasury  board  would  be  published  as  totals  every 
week.  That  is,  the  system  of  accounting  at  each  district 
association  would  be  identical;  the  combined  weekly 
account  would  show  the  conditions  for  the  whole  coun- 
try, and  the  accounts  of  each  district  association  would 
afford  means  of  comparison  and  a  knowledge  of  methods 
followed  in  each  section.  By  way  of  illustration,  certain 
arbitrary  figures  are  introduced  herewith  in  a  combined 
account  in  order  to  show  in  general  the  working  of  a 
system  in  which  the  note-issues  are  separated  from  the 
discounting  operations. 

Typical  accounts: 


I.    OPENING  OF  BANK 


Capital 

District  Associations 
discount 

Dr. 

$100,000,000 

Cr. 

Cash  reserves  (national 
bank     notes,    lawful 
money) $100,000,000 

$100,000,000 

$100,000,000 

Treasuht  Board 
department  of  issue 

A  PROPOSED  BILL 

II.    RECEIPT  OF  GOVERNMENT  DEPOSITS 


195 


District  Associations 
discount 

Dr. 

Capital $100,000,000 

Government  deposits. .   100,000,000 

Cr. 

Cash    (bank-notes 
lawful  money) .  .  . 

or 

. .   $100,000,000 

Law'f  ul  money 

...    100,000,000 

$200,000,000 

$200,000,000 

Treasury  Board 
department  of  issue 

III.     RECEIPT  OF 

BANK  RESERVES 

District  Associations 
discount 

Dt. 

Capital $100,000,000 

Government  deposits. .   100,000,000 
Bank  reserves 400,000,000 

Cr. 

Cash     (bank-notes 
lawful  money) .  .  .  . 

Lawful  money 

Lawful  money 

or 

..$100,000,000 
..   100,000,000 
..   400,000,000 

$600,000,000 

$600,000,000 

Treasury  Board 
department  of  issue 

196  BANKING  PROGRESS 

IV.    READY  FOR  BUSINESS,  DISCOUNTS  TO  BANKS 


Dr. 

Capital 

Government  deposits. 

Bank  reserves 

Bank-deposits 

District  Associations 
discount 

.$100,000,000 

.   100,000,000 
.  400,000,000 
.   200,000,000 

Cr. 

Loans $200,000,000 

Cash   (bank-notes  and 
lawful  money) 600,000,000 

$800,000,000 

$800,000,000 

Treasury  Board 
department  of  i83ub 

V.    ISSUE  OF  NOTES  ON  DEPOSIT  OF  LAWFUL  MONEY 
AT  ISSUE  DEPARTMENT   (Section  17) 


Dr. 

Capital 

Government  deposits. 
Bank  reserves 

District  Associations 
discount 

.$100,000,000 

.  100,000,000 
.  400,000,000 
.   200,000,000 

Cr. 
Loans $200,000,000 

Bank-deposits 

Cash    (bank-notes  and 

lawful  money 400,000,000 

Treasury  board  notes . .   200,000,000 

Dr. 
Notes 

$800,000,000 

$800,000,000 

Treasury  Board 
department  of  issue 

.$200,000,000 

Cr. 

Lawful  money $200,000,000 

$200,000,000 

$200,000,000 

A  PROPOSED  BILL 


197 


VI.    ASSUMPTION  OF  BONDS  FOR-  REDEMPTION   OF 
NATIONAL  BANK  NOTES   (Section  23) 


Capital 

National  bank 

Government  de 
Bank  reserves . 
Bank-deposits . 

Notes 

District  Associations 
discount 

Br. 

$100,000,000 

notes. . .  400.000,000 

>posits..   100,000,000 

400,000,000 

200,000,000 

Cr. 
Loans $200  000  000 

United  States  bonds .  . .   400,000,000 
[320,000,000] 

Cash  (lawful  money)...    [80,000,000] 
Treasury  board  notes .  .   200,000,000 
Bank-notes  and   lawful 

money 400,000,000 

$1,200,000,000 

$1,200,000,000 

Treasury  Board 
department  of  issue 

Dr. 

$200,000,000 

Cr. 
United  States  bonds ...  $  80,000,000 

Lawful  money 120,000,000 

$200,000,000 

$200,000,000 

The  redemption  of  $400,000,000  of  old  national  bank  notes  is  assumed  on 
the  deposit  of  an  equal  amount  of  bonds.  Then,  later,  $80,000,000  of  these 
bonds  are  sent  to  the  issue  department  in  return  for  a  like  sum  of  lawful  money. 


The  separation  of  the  issue  of  notes  from  all  other 
branches  of  business  and  the  publication  of  separate 
statements  of  everything  pertaining  to  them  is  a  power- 
ful safeguard  against  overissues  and  an  important  means 
of  public  education.  Everybody,  including  the  public, 
is  thus  kept  fully  informed  regarding  the  aggregate  vol- 
ume and  the  fluctuations  of  such  issues,  the  amount  and 
frequency  of  redemption,  and  the  state  of  the  gold  re- 
serves; and  such  information  will  help  to  explain  dis- 
count rates  and  other  features  of  the  business  of  the 


198  BANKING  PROGRESS 

VII.    ISSUE  OF  NOTES  BASED  ON  COMMERCIAL   PAPER 


District  Associations 


Dr. 

Capital $100,000,000 

National  bank  notes. .  .   400,000,000 

Government  deposits. .   100,000,000 

Bank  reserves 400,000.000 

Bank-deposits 200,000,000 


$1,200,000,000 


Cr. 

Loans $140,000,000 

United  States  bonds .  . .  320,000,000 

Cash: 
Treasury  board  notes     60,000,000 
Treasury  board  notes  200,000,000 

Lawful  money 80,000,000 

Bank-notes  and  law- 
ful money 400,000,000 


$1,200,000,000 


Treasury  Board 
department  of  issue 


Dt. 

Notes $260,000,000 


$260,000,000 


Cr. 
United  States  bonds.  .  .$  80,000,000 

Commercial  paper 60,000,000 

Lawful  money  of  which 

$86,000,000  must  be 

gold,  i.  e.,  M  of  $260,- 

000,000  notes 120,000,000 


$260,000,000 


From  the  assets  (loans)  of  the  district  associations  $60,000,000  were  taken 
to  the  issue  department  in  exchange  for  an  equal  sum  of  treasury  board  notes. 
This  final  account  would  represent  the  system  in  complete  operation. 

treasury  board  and  the  district  associations  in   which 
the  public  will  have  interest. 


§  9.  To  dispose  of  the  bonds  held  by  national  banks 
to  secure  circulation  the  following  sections  were  intro- 
duced : 

See.  23.  National  banks  shall  not  emit  any  note  issues 
beyond  the  amount  outstanding  on  the  day  six  months  pre- 
ceding the  date  of  the  passage  of  this  act. 

At  any  time  within  twelve  months  from  the  opening  of  said 
Treasury  Board  for  business,  each  District  Association  may 


A  PROPOSED  BILL  199 

receive  at  par  from  any  qualified  National  Bank  within  its  dis- 
trict the  United  States  bonds,  now  bearing  2%  interest,  held 
by  the  Treasury  for  the  security  of  National  Bank  notes,  and 
in  return  said  District  Association  shall  assume  the  redemp- 
tion of  the  national  bank  notes  for  which  said  bonds  were 
pledged. 

Sec.  24.  The  Secretary  of  the  Treasury  is  hereby  empow- 
ered, upon  the  application  of  the  Treasury  Board,  to  exchange 
at  par  three  per  centum  securities,  as  hereafter  described,  for 
the  two  per  centum  bonds  of  the  United  States  bearing  the  cir- 
culation privilege,  which  have  been  obtained  through  the  re- 
spective District  Associations  from  duly  qualified  banks,  in  the 
following  manner:  One-half  of  the  amount  of  bonds  thus  pre- 
sented for  exchange  at  any  one  time  shall  be  converted  into 
three  per  centum  bonds  of  the  United  States  without  the  cir- 
culation privilege,  payable  permissably  in  five  years  and  neces- 
sarily within  twenty  years  from  the  date  of  issue;  and  one-half 
of  the  amount  of  bonds  thus  presented  for  exchange  at  any 
one  time  shall  be  converted  into  one-year  notes  of  the  United 
States,  bearing  three  per  centum  interest.  Provided,  that  the 
United  States  shall  have  the  right  to  renew  said  one-year  notes 
by  due  notice  to  said  Treasury  Board  before  maturity;  or  to 
pay  them  off  in  whole  or  in  part  at  any  time,  provided  further, 
that  aimual  renewals  shall  not  be  made  after  twenty  years. 

The  Treasury  Board  shall  be  permitted  at  any  time,  with 
the  consent  of  the  Secretary  of  the  Treasury,  to  offer  any  part 
of  its  holdings  of  United  States  bonds  or  one-year  notes  thus 
refunded  at  sale  for  gold;  Provided,  that  the  United  States  re- 
serves the  right  at  any  time  to  pay  off  any  of  such  bonds  or 
notes  before  maturity,  or  to  purchase  any  of  them  at  par  for 
the  trustees  of  the  postal  savings,  or  otherwise. 

Sec.  25.  The  additional  interest  charge  incurred  by  the 
United  States  Government  as  a  result  of  the  refunding  of  the 
two  per  cents  into  three  per  cents  shall  be  paid  by  the  District 
Associations  out  of  their  gross  receipts  in  such  a  manner  and 
at  such  times,  not  less  than  once  a  year,  as  shall  be  determined 
by  the  Treasury  Board  with  the  consent  of  the  Secretary  of  the 
Treasury.  Each  Association  shall  pay  such  a  portion  of  the 
total  amount  as  its  capital  and  surplus  bear  to  the  aggregate 
capital  and  surplus  of  all  the  Associations. 


200  BANKING  PROGRESS 

Sec.  26.  All  provisions  of  law  requiring  national  banks  to 
hold  or  to  transfer  and  deliver  to  the  Treasurer  of  the  United 
States,  bonds  of  the  United  States  other  than  those  required 
to  secure  outstanding  circulating  notes  and  Government  deposits 
are  hereby  repealed. 

§  10.     Reserves  are  disposed  of  as  follows: 

Sec.  27.  The  District  Associations  shall  not  pay  interest  on 
deposits. 

Sec.  28.  Each  qualifying  bank  must  conform  to  the  fol- 
lowing requirements  as  to  reserves  held  against  deposits: 

First:  If  located  in  a  town  having  a  population  of  6000  in- 
habitants or  less,  and  having  a  paid-in  and  unimpaired  capital 
of  not  over  $50,000,  each  qualifying  bank  shall  deposit  in  lawful 
money  with  its  District  Association  five  per  centum  of  its  de- 
mand deposits  of  whatsoever  kind. 

Second:  If  located  in  a  town  having  a  population  of  more 
than  6000  inhabitants,  and  having  a  paid-in  and  unimpaired 
capital  of  more  than  $50,000,  each  qualifying  bank  shall  in 
its  accounts  distinguish  between  (1)  bankers'  balances,  (2)  in- 
dividual demand  deposits,  and  (3)  time  deposits. 

Bankers'  balances  must  be  protected  to  the  extent  of  40  per 
centum,  of  which  not  less  than  20  per  centum  shall  be  in  law- 
ful money;  and  of  said  20  per  centum,  not  less  than  8  per  cen- 
tum must  be  deposited  with  its  District  Association;  while 
the  remainder  of  said  40  per  centum  (or  20  per  centum)  shall 
consist  of  commercial  paper,  as  described  in  Section  8. 

Individual  demand  deposits  must  be  protected  to  the  extent 
of  .30  per  centum,  of  which  not  less  than  15  per  centum  shall 
be  in  lawful  money;  and  of  said  15  per  centum,  not  less  than  8 
per  centum  must  be  deposited  with  its  District  Association, 
while  the  remainder  of  said  30  per  centum  (or  15  per  cen- 
tum) shall  consist  of  commercial  paper,  as  described  in  Sec- 
tion 8. 

Time  deposits  payable  in  30  days  or  less  must  be  covered 
in  the  same  manner  as  individual  demand  deposits;  on  other 
time  deposits,  5  per  centum  reserves  are  to  be  kept. 

Credit  deposits  with  its  District  Association  shall  be  counted 
by  any  qualified  member  bank  as  a  part  of  its  required  re- 
serves;  but  Treasury  Board  notes  shall  not  be  so  counted. 


A  PROPOSED  BILL  201 

The  question  of  banking  reserves  is  much  simplified  if 
a  separation  is  made  between  (1)  reserves  for  note-issues 
and  (2)  reserves  for  deposits.  In  the  national  banking 
system  reserves  are  kept  solely  for  deposits,  because  the 
notes  are  protected,  not  by  reserves,  but  by  government 
bonds  and  a  5  per  cent  redemption  fund  (although  this 
same  redemption  fund  can  be  counted  as  part  of  the  re- 
serves behind  deposits).  In  the  Monetary  Commission 
Plan  confusion  is  introduced  by  going  back  to  our  early 
defective  banking  system,  in  which  one  reserve  was  held 
against  both  notes  and  deposits.  In  any  rational  mod- 
ern system  the  protection  for  the  notes  should  be  pro- 
vided for  quite  independent  of  the  rules  for  banking  re- 
serves behind  deposits.  On  this  assumption  nothing 
further  need  be  said  as  to  the  reserves  for  redeeming  notes. 

Deposits  in  commercial  banks  may  arise  either  (1) 
from  daily  deposits  of  cash  and  checks  by  business  firms, 
or  (2)  from  a  loan  operation.  The  immediate  and  first 
result  of  a  loan  is  the  creation  of  a  deposit-account  to 
the  credit  of  the  borrower.  Also,  business  concerns  gen- 
erally expect  loans  from  a  bank  about  in  proportion  to 
the  amount  of  their  average  deposits.  Consequently, 
in  most  commercial  banks  the  total  item  of  loans  does 
not  vary  much  from  the  total  item  of  deposits;  if  loans 
are  much  below  deposits,  it  shows  conservative  lending. 
Since  deposits  are  chiefly  the  outcome  of  loans,  or  of 
deposits  of  checks  drawn  on  other  credit  accounts,  re- 
serves are  most  closely  connected  with  the  borrowing 
or  discounting  at  a  bank.  If  loans  are  increased,  there 
follows  an  increase  of  deposits,  and  hence  an  alteration 
in  the  percentage  of  reserves;  and  vice  versa,  if  loans  de- 
cline. Consequently,  the  question  of  reserves  has  to  be 
considered  chiefly  in  connection  with  the  regional  insti- 
tutions vested  with  the  power  to  make  discounts. 


202  BANKING  PROGRESS 

Given  a  certain  amount  of  demand-deposits,  those  in 
whose  favor  they  stand  may  call  for  the  use  of  their 
funds  either  (1)  in  the  form  of  notes  and  cash,  or  (2)  by 
drawing  checks  on  their  accounts.  Which  of  these  two 
forms  will  be  resorted  to  depends  upon  the  business 
habits  and  customs  of  the  patrons  of  the  bank.  In  large 
financial  centres,  and  in  most  cities,  large  pajTnents  are 
made  chiefly  by  checks;  in  rural  districts,  where  men  are 
at  a  distance  from  banks,  notes  are  often  needed  to  com- 
plete a  cash  sale;  but  even  here  checks  on  banks  are  fast 
being  introduced.  The  point  to  be  kept  in  mind  is  that 
banks  must  provide  whichever  means  of  payment  is  de- 
manded by  their  customers. 

The  pivotal  question,  however,  is  the  relation  of  re- 
serves to  the  power  of  a  bank  to  lend.  If  new  loans  are 
made,  the  demand-deposits  are  increased  and  the  per- 
centage of  reserves  to  deposits  is  lowered.  Under  pres- 
ent conditions,  the  borrower  who  wishes  cash  (e.  g.,  to 
meet  his  pay-roll)  will  draw  from  lawful-money  reserves, 
thus  again  lower  the  percentage  of  reserves,  and  cripple 
the  immediate  lending  power  of  the  banks.  If,  however, 
the  district  associations  were  empowered  to  exchange 
picked  commercial  paper  for  "treasury  notes"  at  the 
offices  of  the  treasury  board,  they  could  fill  up  their  re- 
serves whenever  a  legitimate  demand  for  discounts  arose 
from  individual  banks;  and  the  individual  banks  could 
draw  these  notes  from  their  accounts  with  the  district 
associations  whenever  the  public  needed  cash.  Thus 
the  individual  banks  would  be  protected  from  drains  on 
their  lawful-money  reserves  by  being  able  to  pay  out 
"treasury  notes"  whenever  the  owner  of  a  deposit- 
account  might  choose  to  want  cash  (instead  of  drawing 
checks  on  his  deposit-account).  In  effect,  there  are  two 
restraints  on  overexpansion  in  regard  to  notes:  (1)  the 


A  PROPOSED  BILL  203 

surveillance  over  the  commercial  paper  presented  by 
individual  banks  to  the  district  associations,  accompanied 
by  a  rising  scale  of  commissions,  although  the  rate  of 
discount  is  uniform  in  the  district;  and  (2)  another  re- 
straint in  passing  paper  from  the  district  association  to 
the  treasury  board  for  notes.  The  individual  member 
banks  should  not  be  allowed  to  count  "treasury  notes" 
as  reserves,  but  should  be  obliged  to  aid  in  founding  our 
monetary  system  throughout  the  country  broadly  on 
gold.  If  "treasury  notes"  were  to  be  counted  in  reserves, 
there  would  be  a  premium  on  holding  them,  getting  more, 
and  not  sending  them  in  for  redemption  when  issues 
were  not  called  for  by  the  public.  If  individual  banks 
could  count  deposits  with  district  associations  as  re- 
serves, it  would  encourage  deposits  with  other  than  cen- 
tral reserve  city  banks.  It  may  not  be  logical  to  allow 
deposits  to  count  as  reserves,  and  not  notes,  but  practical 
considerations  should  govern.  If  cash  reserves  are  needed 
at  home,  individual  banks  can  always  get  the  notes  re- 
deemed in  gold.  Thus  the  contraction,  as  well  as  the 
expansion,  of  "treasury  notes"  is  obtained,  which  fulfils 
the  true  meaning  of  elasticity  of  the  currency. 

Now  we  are  in  a  position  to  discuss  the  idea  that  we 
must  have  a  "centralization  of  reserves,"  in  order  to 
prevent  the  scattering  of  reserves  (which  is  undoubtedly 
a  great  evil  in  times  of  alarm).  It  is  implied  that  all  the 
cash  reserves  must  be  under  one  control,  i.  e.,  taken  away 
from  New  York  and  placed  in  Washington.  Why.^^  In 
order  that  the  reserves  should  be  physically  transferred 
from  one  place  to  another  when  needed.'^  That  is  not 
credible.  The  whole  question  is  one  of  mobilization  of 
reserves  (no  matter  where  the  exact  spot  of  storage  is)  in 
order  to  make  lending  possible  on  picked  commercial 
paper  in  time  of  stress.     There  is  nothing  to  the  reserve 


204  BANKING  PROGRESS 

question  except  its  effect  on  lending.  The  so-called  cen- 
tralization of  reserves  is  disposed  of  by  any  plan  which 
enables  discounts  to  be  made  in  amounts  as  large  as  is 
consistent  with  safety  and  with  the  needs  of  legitimate 
borrowers. 

The  only  real  fear  those  have  who  demand  some  "cen- 
tralization" is  that  otherwise  no  institution  {i.  e.,  no  dis- 
trict association)  will  have  enough  resources,  or  be  big 
enough,  to  meet  emergency  demands  and  secure  respect 
in  Europe.  This  objection  can  be  met  by  having  fewer 
district  associations  and  having  each  one  larger;  instead 
of  twenty,  have  no  more  than  ten.  In  Chicago,  for  in- 
stance, in  1912,  one  large  bank  should  have  been  able  at 
once  to  get  $10,000,000  added  to  its  reserv^es  by  redis- 
counting  good  paper.  The  $10,000,000  credited  as  a  de- 
posit to  Bank  X  in  Chicago  as  the  result  of  the  rediscount- 
ing  would  count  as  part  of  its  reserve.  That  instantly 
touches  its  power  to  lend.  Is  this  not  the  whole  point  at 
issue?  Why  is  there  a  need  of  any  further  "centralization 
of  reserves"?  A  bank  can  draw  "treasury  notes"  from 
its  deposit-account  with  the  district  association,  if  cash  is 
wanted  in  the  Northwest,  or  elsewhere.  That,  of  course, 
would  lower  its  lately  increased  reserve,  but  the  plan  is 
made  for  just  that  purpose — to  enable  notes  to  be  paid 
out  in  time  to  meet  crop-movements.  And  the  bank  can 
get  more  reserves  in  the  same  way,  if  there  is  a  real  need. 
But  it  is  to  be  remembered  here  that  the  bank  might 
not,  as  now,  draw  notes  from  the  district  association  as 
just  suggested :  by  the  system  of  transfers  allowed  in  this 
plan,  the  given  bank  could  transmit  a  credit  to  any  other 
bank-account  with  any  other  district  association;  that 
deposit-credit  would  count  as  reserves  to  the  given  indi- 
vidual bank;  and  the  lending  power  of  that  bank  would 
be  directly  affected  in  the  interest  of  its  local  borrowers. 


A  PROPOSED  BILL  205 

What  more  could  be  accomplished  by  so-called  "centrali- 
zation of  reserves"?  Are  not  some  persons  caught  more 
by  a  phrase  than  by  the  essential  thing  to  be  attained? 

§  11.    Next  we  may  present  the  matter  of  earnings. 

Sec.  35.  The  earnings  of  each  District  Association  shall  be 
disposed  of  in  the  following  manner: 

After  the  payment  of  all  expenses  and  the  reduction  of  losses,  if 
there  be  any,  the  semi-annual  earnings  shall  be  distributed  among 
the  qualifying  banks  in  proportion  to  the  number  of  shares 
owned  by  each,  except  that  earnings  in  excess  of  four  per  cent 
per  annum  of  the  total  paid-up  capital  stock  shall  be  distributed 
as  follows:  One-half  of  the  excess  shall  be  distributed  among 
the  qualifying  banks  and  one-half  be  transferred  to  an  account 
of  the  Government  of  the  United  States  on  the  books  of  the 
Treasury  Board,  provided  that  the  total  amount  of  said  surplus 
paid  to  the  qualifying  banks  shall  not  exceed  one  per  cent  of 
the  total  paid-up  capital  stock,  it  being  the  intent  of  this  act 
that  all  earnings  in  excess  of  five  per  cent  of  the  total  paid-up 
capital  stock  shall  be  credited  to  the  account  of  the  Govern- 
ment of  the  United  States  on  the  books  of  the  Treasury 
Board. 

After  each  dividend  has  been  declared,  all  additional  earn- 
ings shall  be  transferred  to  the  account  of  the  Government  of 
the  United  States  on  the  books  of  said  Treasury  Board,  and 
shall  be  disposed  of  by  said  Treasury  Board  as  follows,  and  in 
the  following  order  of  precedence: 

(a)  A  sum  equal  to  one-fourth  of  one  per  cent  of  the  capital 
stock  of  each  District  Association  shall  be  set  apart  annually 
for  eight  years,  to  form  a  contingent  fund  to  meet  any  possible 
losses.  In  case  of  liquidation,  this  fund  shall  be  credited  to 
the  account  of  the  United  States  Treasury. 

(6)  A  sum  equal  to  one  per  cent  of  the  capital  stock  shall  be 
assigned  annually  to  a  surplus  fund  until  such  fund  shall  amount 
to  20  per  cent  of  said  capital. 

(c)  Of  United  States  notes  held  in  special  reserve  by  the 
Department  of  Issue,  as  hereinbefore  provided,  a  portion  equal 
to  the  balance  on  the  account  of  the  Government  of  the  United 


206  BANKmG  PROGRESS 

States  shall  be  returned  to  the  Secretary  of  the  Treasury  for 
cancellation  and  destruction,  the  Government's  account  being 
debited  with  the  amount  thus  returned;  Provided  that  the  max- 
imum amount  thus  returned  shall  not  exceed  the  amount  of 
the  total  issue  of  such  notes  in  excess  of  the  $150,000,000  gold 
reserve  held  by  the  Secretary  of  the  Treasury  for  their  redemp- 
tion. After  all  the  United  States  notes  in  excess  of  said  $150,- 
(jOO,000  gold  reserve  shall  have  been  cancelled  and  destroyed 
in  this  manner,  all  additional  holdings  of  such  notes  by  the 
District  Association  and  all  such  notes  in  any  manner  coming 
into  the  possession  of  the  District  Associations  in  the  future 
shall  be  exchanged  for  gold  at  the  Treasury  of  the  United  States, 
and  the  notes  so  exchanged  shall  be  cancelled  and  destroyed; 
and  all  such  notes  thereafter  coming  in  any  manner  into  the 
possession  of  the  Government  of  the  United  States  shall  in 
like  manner  be  redeemed,  cancelled  and  destroyed. 

(d)  Any  such  earnings  as  are  not  disposed  of  in  the  manner 
indicated  in  paragraphs  (a),  (6),  and  (c)  shall  be  applied  to  the 
purchase  at  par  from  the  District  Associations  or  the  Treasury 
Board  of  holdings  of  the  three  per  cent  refunded  bonds  here- 
inbefore described. 

(e)  After  all  such  purposes  mentioned  in  this  section  shall 
have  been  fulfilled,  any  surplus  earnings  of  said  District  Asso- 
ciation shall  be  paid  into  the  account  of  the  United  States 
Treasury. 

The  provisions  of  Section  35  are  based  on  two  prin- 
ciples: (1)  that  the  institutions  created  by  this  act  should 
not  be  influenced  in  their  operations  by  the  desire,  or 
the  need,  of  earning  large  dividends  for  their  stockhold- 
ers; and  (2)  that  any  profits  accruing  to  the  United  States 
Government  from  their  operations  should  be  used  in  the 
improvement  of  our  currency  and  in  the  payment  of  the 
national  debt. 

What  is  needed  is  not  an  additional  source  of  revenue 
for  our  banks  and  trust  companies,  but  means  for  their 
more  complete  functioning,  to  the  end  that  financial 
crises  may  be  avoided  and  the  agricultural,  industrial. 


A  PROPOSED  BILL  207 

and  commercial  interests  of  the  country  be  better  served. 
The  treasury  board  and  the  district  associations  should 
be  guided  solely  by  considerations  of  the  latter  kind,  and 
to  this  end  this  section  limits  the  dividends  that  can  be 
paid  to  stockholders  to  5  per  cent  of  their  holdings  of 
stock.  It  is  believed  that  dividends  of  at  least  this 
amount  will  be  earned  without  special  effort  on  the  part 
of  the  associations,  and  that  such  dividends  will  consti- 
tute sufficient  financial  remuneration  to  the  banks  and 
trust  companies  that  join  the  association,  their  chief 
remuneration  being  the  rediscount  and  other  advantages 
which  membership  will  bring. 

It  is  more  than  likely  that  actual  earnings  will  be 
greatly  in  excess  of  expenses  plus  5  per  cent  of  the  cap- 
ital stock.  In  this  case  means  will  be  provided  for  rid- 
ding our  currency  of  the  United  States  notes  which  take 
the  place  in  our  currency  of  an  equivalent  amount  of 
gold  and  impose  upon  the  Treasury  the  dangerous  obliga- 
tion of  maintaining  a  gold  reserve.  The  requirement 
according  to  the  provisions  of  this  act  will  not  occasion 
even  a  temporary  contraction  of  the  volume  of  the  cur- 
rency, since  treasury  notes  will  take  their  place  as  fast 
as  they  are  withdrawn  from  circulation,  and  gold  will 
take  their  place  in  the  reserves  of  the  district  association 
when  they  are  cancelled  and  retired.  Neither  will  their 
retirement  occasion  any  expense  to  the  government;  on 
the  contrary,  by  these  means  a  portion  of  the  public 
debt  will  be  paid  off  by  profits  derived  from  private  busi- 
ness agencies. 

After  the  retirement  of  the  United  States  notes  and  the 
accumulation  of  adequate  contingent  and  surplus  funds, 
the  use  of  surplus  profits  in  the  purchase  of  3  per  cents 
from  the  district  associations  is  desirable,  since  the  sub- 
stitution of  commercial  paper  and  gold  for  bonds  as  cover- 


208  BANKING  PROGRESS 

ing  for  the  treasury  notes  should  be  accomplished  at  the 
earliest  possible  moment,  and  while  such  substitution 
can  be  accomplished  by  the  sale  of  the  bonds  on  the  open 
market,  such  sales  may  not  happen  to  be  in  the  inter- 
ests of  the  Treasury  at  the  time  they  ought  to  be  made 
in  the  interests  of  the  district  associations  and  the  cur- 
rency. 

This  section  must  be  considered  in  connection  with 
Sections  17  and  18,  which  provide  for  the  gradual  retire- 
ment of  the  greenbacks,  and  the  national  bank  notes. 
Under  the  operation  of  its  provisions,  these  forms  of  cur- 
rency would  gradually  accumulate  in  the  reserves  of  the 
treasury  board  and  notes  of  the  board  would  take  their 
place  in  the  circulation  of  the  country. 

Sections  29-34  on  investments  are  similar  to  Sections 
32-36  and  38  of  the  National  Monetary  Commission 
Plan,^  and  need  not  be  reproduced  here.  In  Section  30 
authority  was  granted  to  district  associations  to  invest  in 
the  short-time  paper  of  foreign  governments.  Such  in- 
vestments would  have  the  special  advantage  of  putting 
the  district  associations  in  a  position  to  draw  gold  from 
abroad,  either  through  collection  at  maturity  or  redis- 
counts on  foreign  markets. 

§  12.  The  old  problem  of  correcting  the  evils  of  the 
independent  treasury  is  taken  up  as  follows: 

Sec.  36.  The  Government  of  the  United  States  shall  upon 
the  organization  of  the  Treasury  Board  deposit  its  general 
funds  in  any  of  said  District  Associations,  and  thereafter  all 
receipts  of  the  Government,  exclusive  of  trust  funds,  shall  be 
deposited  with  said  District  Associations,  and  all  disburse- 
ments by  the  Government  shall  be  made  through  said  District 
Associations. 

'  See  Appendix  II. 


A  PROPOSED  BILL  209 

The  elimination  of  the  disturbances  on  the  money 
market  occasioned  by  the  operations  of  our  independent 
treasury  system  is  one  of  the  chief  advantages  to  be  at- 
tained by  the  establishment  of  the  treasury  board  and 
district  associations.  The  present  section  provides  for 
the  use  of  the  district  associations  by  the  government  as 
a  place  of  deposit  for  all  its  cash  except  the  trust  funds. 

The  retention  by  the  Treasury  of  these  latter  funds, 
consisting  of  the  gold  held  for  the  redemption  of  the  gold 
certificates,  the  $150,000,000  gold  reserve  held  against 
the  United  States  notes  and  the  silver  dollars  held  for 
the  redemption  of  the  silver  certificates,  is  a  matter  of 
indifference  to  the  money  market,  the  volume  of  the  cur- 
rency not  being  in  any  way  affected  by  them  and  the 
redemption  operations  based  upon  them.  It  is  the 
locking  up  of  funds  in  the  Treasury  when  receipts  exceed 
expenditures  and  their  deposit  and  withdrawals  from 
the  depository  banks  at  the  option  of  the  secretary  of 
the  treasury  that  causes  the  trouble  which  it  is  proposed 
to  remove  by  making  the  district  associations  the  deposi- 
tories and  disbursing  agents  of  the  government. 

§  13.  Section  37  of  this  bill  on  foreign  banking  was 
the  same  as  Section  57  of  the  plan  of  the  National  Mon- 
etary Commission,  and  need  not  be  reprinted.  (See  Ap- 
pendix II.) 

This  section  has  nothing  to  do  directly  with  the  dis- 
trict associations  and  might  easily  be  included  in  a  sepa- 
rate act.  It  is,  however,  not  inappropriate  to  include  it, 
since  the  district  associations,  by  creating  a  market  for 
commercial  paper,  will  greatly  increase  our  facilities  for 
transacting  foreign  business,  and  thus  make  desirable 
the  creation  of  the  kind  of  institution  for  foreign  bank- 
ing here  provided  for. 


210  BANKING  PROGRESS 

The  provisions  of  this  section  give  the  district  associa- 
tions full  authority  to  replenish  their  gold  reserves  by 
negotiations  on  foreign  markets  if  necessary.  Such  au- 
thority is  necessary  in  the  interests  of  safety  and  their 
proper  management  at  all  times. 

To  what  extent  the  district  associations  would  find  it 
necessary  or  desirable  to  open  offices  in  foreign  countries 
is  uncertain,  but  foreign  connections  in  the  form  of  ac- 
counts mth  foreign  banks  and  agencies  would  be  indis- 
pensable. 

Authority  to  buy  and  sell  foreign  bills  is  justified  on 
the  same  grounds  as  investments  in  the  short-time  paper 
of  foreign  governments.  A  portfolio  of  foreign  bills 
would  constitute  the  best  reserve  protection  the  district 
associations  could  have,  since  such  bills  could  ordinarily 
be  turned  into  gold  at  any  time. 

§  14,  Provision  as  follows  was  made  for  reports  and 
examinations : 

Sec.  38.  Monthly  balance  sheets  in  the  form  prescribed  by 
the  Treasury  Board,  guaranteed  as  to  correctness  by  their  re- 
spective Boards  of  Directors,  shall  be  supplied  to  the  District 
Associations  by  all  banks  whose  names  appear  on  the  paper 
offered  for  discount. 

Balance  sheets  of  firms  and  corporations  whose  paper  is 
offered  for  discount,  in  the  form  prescribed  by  the  Treasury 
Board,  shall  also  on  request  of  the  District  Association  be  fur- 
nished by  the  bank  offering  such  paper  for  discount,  and  such 
balance  sheets  shall  represent  no  asset  at  more  than  its  actual 
value  and  no  liability  at  less  than  its  true  amount. 

The  Treasury  Board  shall  make  a  report  showing  the  totals 
of  the  principal  items  of  its  balance  sheet  and  of  all  the  Dis- 
trict Associations  once  a  week.  These  reports  shall  be  made 
public.  In  addition,  full  reports  shall  be  made  to  the  Comp- 
troller of  the  Currency  by  said  Treasury  Board,  coincident  with 
the  five  reports  called  for  each  year  from  the  national  banks. 


A  PROPOSED  BILL  211 

All  reports  of  national  bank  examiners  in  regard  to  the  con- 
dition of  banks  shall  hereafter  be  made  in  duplicate  and  one 
copy  filed  at  the  office  of  the  Treasury  Board  for  the  confiden- 
tial use  of  its  executive  officers  and  District  Associations. 

The  Manager  of  each  District  Association  may  call  for  re- 
ports of  State  bank  examiners  applying  to  State  banks  quali- 
fying for  rediscounts,  and  in  case  such  reports  are  not  for  any 
reason  supplied,  the  District  Association  shall  have  the  power 
to  make  examination  of  such  banks  through  its  own  officers. 

The  Secretary  of  the  Treasury  shall  annually  appoint  a  com- 
mittee of  five  persons,  at  least  three  of  whom  shall  be  expert 
accountants,  to  make  from  time  to  time  a  careful  examination 
of  the  conditions  and  business  of  the  Treasury  Board  and  the 
District  Associations  and  to  make  at  least  once  a  year  a  public 
statement  of  the  results  of  such  examination. 

The  Treasury  Board  shall  also  annually  appoint  from  among 
their  number  a  committee  of  three  persons  to  make  at  least 
once  in  three  months  a  careful  examination  into  the  condition 
and  business  of  the  Board.  This  committee  shall  report  to  the 
Treasury  Board. 

The  balance-sheet  reports  required  from  qualifying 
banks  and  from  corporations,  firms  and  individuals  whose 
names  appear  on  the  paper  offered  for  discount  are  im- 
portant, not  only  because  they  will  supply  the  data 
needed  in  the  determination  of  the  quality  of  such  paper 
and  the  character  and  methods  of  business  of  the  insti- 
tutions presenting  it,  but  because  of  the  influence  it  will 
have  on  the  conduct  of  business  by  the  promotion  of 
balance-sheet  accounting.  To  compel  business  concerns 
frequently  to  prepare  accurate  balance-sheets  will  go  far 
toward  promoting  sound  and  eliminating  unsound  opera- 
tions. 

The  affairs  of  the  treasury  board  and  district  associa- 
tions must  be  given  wide  publicity,  because  its  operations 
will  constitute  the  money-market  barometer  of  the  coun- 
try.    Hence  the  requirement  of  the  publication  of  weekly 


212  BANKING  PROGRESS 

balance-sheets.  Every  precaution  should  also  be  taken 
that  their  affairs  are  conducted  in  a  proper  manner. 
Hence  the  requirement  of  reports  to  the  comptroller  of 
the  currency  and  of  examinations  by  expert  accountants 
and  financiers  and  by  committees  of  the  directors. 

§  15.  The  next  sections  deal  with  the  serious  diffi- 
culties of  clearings  and  collections: 

Sec.  39.  Whenever  a  District  Association  shall  have  re- 
ceived for  collection  checks  and  drafts  drawn  on  institutions 
outside  its  own  district,  it  shall  send  to  each  of  the  other  Dis- 
trict Associations  those  drawn  upon  institutions  within  the  dis- 
trict of  said  Association  with  the  aggregate  amount  of  the 
checks  and  drafts  so  sent.  It  shall  credit  to  the  account  of 
each  Association  the  checks  and  drafts  in  like  manner  sent  in 
for  collection.  At  the  close  of  each  day's  business  each  Dis- 
trict Association  shall  send  to  the  Treasury  Board  hereinafter 
described  a  statement  of  the  amounts  thus  debited  and  credited, 
together  with  the  balances  due  the  other  Associations  or  due 
by  them  to  it,  and  in  case  the  net  balance  is  adverse,  it  shall 
accompany  said  statement  with  a  check  to  the  amount  of  said 
adverse  balance  drawn  against  its  account  with  the  Treasury 
Board.  Each  District  Association  shall  keep  with  the  Treasury 
Board  a  balance  sufficient  to  cover  such  checks.  The  Treasury 
Board  shall  each  day  credit  to  the  accounts  of  the  District 
Associations  having  favorable  balances  the  proceeds  of  the 
checks  thus  received. 

The  Pujo  Committee  raised  a  question  as  to  great 
sums  earned  by  city  banks  in  collections  of  checks.  The 
provisions  of  this  bill  cover  all  that  matter,  and  provide 
for  collections  of  checks  with  an  advantage  to  all  the 
banks,  large  or  small.  These  advantages  arise  from  the 
creation  of  district  associations,  superimposed  on  exist- 
ing clearing-houses,  as  already  described.  The  district 
associations  will  assume  not  only  the  discounting  func- 


A  PROPOSED  BILL  213 

tions  of  the  clearing-houses  (accompanied  with  the  in- 
hibition of  clearing-house  certificates),  but  also  introduce 
an  economy  in  the  present  system  of  collections. 

This  bill  allows,  of  course,  the  system  of  transfers  from 
one  account  to  another  on  the  books  of  any  district  asso- 
ciation, which  was  contained  in  the  plan  of  the  Monetary 
Commission.  This  is,  in  effect,  the  well-known  method 
of  giroverkehr  by  the  Reichsbank.  The  clearing  of  coun- 
try items  is  not  provided  for  by  the  German  system;  for 
checks  drawn  on  deposits  are  little  used  in  Germany. 
This  bill  goes  further:  it  provides  for  needs  created  by 
the  customs  of  our  own  country.  It  is  made  the  duty 
of  the  district  associations  to  further  in  every  possible 
way  the  clearing  of  checks  between  banks  in  all  parts 
of  the  country.     The  method  is  simple. 

Nothing  in  this  bill  interferes  with  the  offsetting  of 
checks  by  the  137  clearing-houses  within  their  respective 
cities.  In  each  city,  however,  banks  would  sort  checks 
into  (1)  city,  or  (2)  outside  items.  The  former  would 
go  to  the  city  clearing-house,  as  now.  The  latter  would 
go  to  the  district  association,  and  the  course  of  proceed- 
ings would  be  as  follows:  Bank  X,  in  Chicago,  might 
present  to  its  district  association  (in  Chicago)  items 
composed  of  checks  on  banks  outside  of  Chicago,  to,  say, 
$1,000,000.  Immediately  Bank  X,  a  qualified  bank, 
having  an  account  at  the  district  association,  would  be 
credited  with  the  $1,000,000,  without  the  expense  or 
delay  of  collecting  checks  all  over  the  country  (varying 
from  two  to  ten  days),  and  without  the  loss  of  interest 
thereby  involved.  These  items  are  at  once  sorted  by  the 
Chicago  district  association  into  two  classes:  (1)  those  on 
banks  within  the  territory  of  the  Chicago  district  asso- 
ciation, and  (2)  those  on  banks  in  other  district  associa- 
tions.   For  (1),  the  checks  would  be  debited  to  the  ac- 


214  BANKING  PROGRESS 

counts  of  qualified  banks  on  the  books  of  the  Chicago 
district  association  (since  only  checks  of  qualified  banks 
would  be  handled).  For  (2)  the  checks  would  be  sorted 
according  to  the  district  association  in  which  the  banks 
are  situated,  and  each  package  sent  immediately  to  its 
respective  district  association.  On  receipt  by  each  dis- 
trict association  the  checks  are  charged  to  the  accounts 
of  the  qualified  banks  in  each  district  association.  Since 
each  qualified  bank's  account  would  be  thus  credited 
and  debited  on  the  books  of  its  respective  district  associa- 
tion, only  balances  need  be  paid;  and  these  balances 
would  be  paid  by  checks  drawn  on  the  district  associa- 
tion, thus  avoiding  all  needless  movement  of  cash  be- 
tween both  district  associations  and  individual  banks. 
The  economy  of  this  process  would  be  very  important. 
The  expense  of  recording  each  item  for  verifying  its  prog- 
ress would  be  considerable,  and  not  to  be  overlooked. 
The  present  wasteful  shipments  of  actual  cash  from  large 
cities  to  distant  parts  of  the  country  would  cease.  The 
cost  of  collections,  about  which  so  much  complaint  has 
been  made,  would  be  reduced.  The  large  banks  would 
have  a  cash  credit  immediately  on  deposit  of  outside 
items.  Such  a  provision  for  the  extension  of  the  clear- 
ing-house function  throughout  the  whole  country  (in- 
stead of  being  confined  within  any  one  city),  through  the 
district  associations,  directly  under  governmental  super- 
vision, would  tend  to  remove  all  existing  clearing-houses, 
which  are  unincorporated  and  voluntary  associations. 
Thus  whatever  problems — if  any — were  raised  by  the 
Pujo  Committee  would  be  fully  met  by  the  provisions  of 
this  bill  which  puts  under  lawful  control  both  the  dis- 
counting and  offsetting  functions  of  existing  clearing- 
houses. In  this  case,  the  law  could  be  said  to  have  over- 
taken the  voluntary  and  extralegal  operations  of  trade 


A  PROPOSED  BILL  215 

and  banking,  the  supervision  of  which  is  undertaken  in 
the  interest  of  equality  to  all,  big  or  little. 

It  is  to  be  observed,  finally,  that  these  provisions,  for 
assuming  and  legalizing  all  the  functions  of  clearing- 
houses— especially  the  inhibition  of  clearing-house  cer- 
tificates in  time  of  panic — form  the  strongest  possible 
reasons  why  all  banks  should  qualify  with  their  respec- 
tive district  associations.  They  could  not  afford  to  take 
the  risk  of  staying  out;  while,  if  they  come  in,  they 
gain  positive  advantages  in  collections  as  well  as  in  re- 
serves, and  full  opportunity  for  rediscounts  without  fear 
or  favor. 

It  may  not  be  desirable  to  force  this  system  of  collec- 
tions and  clearings  at  the  outset;  but  to  make  it  possible 
under  the  act  and  permit  it  to  develop  by  a  natural  and 
gradual  growth. 


CHAPTER  X 
THE  FEDERAL  RESERVE  ACT 

§  1.  Out  of  all  the  efforts  for  reform  in  the  past  gen- 
eration, and  from  the  various  proposals  of  different 
minds,  there  was  actually  passed  in  the  Federal  Reserve 
Act  of  1913  the  most  comprehensive  monetary  and  bank- 
ing law  ever  placed  on  our  statute-books  in  the  whole 
history  of  the  nation.  It  marks  the  culmination  of  our 
banking  progress.  Toward  this  result  many  events  have 
contributed.  It  is  an  interesting  story  with  a  happy 
ending. 

In  order  to  be  able  to  test  the  new  legislation,^  it  will 
be  interesting  to  summarize  here  the  defects  in  our  bank- 
ing and  currency  system  which  were  generally  accepted 
at  the  beginning  of  the  recent  campaign  (1910-1913):  an 
inelastic  bank-note  circulation;  an  even  more  dangerously 
inelastic  credit  system;  ineffective  use  of  a  large  supply 
of  gold;  a  scattering  of  reserves  and  lack  of  co-operative 
action  by  banks  in  times  of  stress;  a  rigid  reserve  system 
which  induced  panics;  State  banks  and  trust  companies 
doing  a  commercial  business  but  in  different  systems; 
an  independent  treasury  divorced  from  the  money  mar- 
ket which  imperilled  bank  reserves  in  times  of  diflSculty; 
the  drift  of  idle  funds  to  the  call-loan  market  where  they 
fed  stock  speculation;  and  the  want  of  American  banking 
facilities  in  other  countries  to  aid  our  foreign  trade.     It 

*  The  original  text  of  the  act  is  given  in  the  First  Annual  Report  of  the  Fed- 
eral Reserve  Board,  December  31,  1914,  pp.  25-44,  as  well  as  in  many  other 
places.  In  amended  form  it  can  be  obtained  by  any  one  on  application  to  the 
Federal  Reserve  Board,  Treasury  Department,  Washington,  D.  C. 

216 


THE  FEDERAL  RESERVE  ACT  217 

will  be  fitting  to  watch  as  we  go  on  whether  these  de- 
mands, which  were  formulated  before  the  new  law  was 
even  drawn  up,  have  been  effectively  covered. 

We  may  then  proceed  to  an  examination  of  the  act  of 
December  23,  1913.  In  order  to  secure  clearness  it  may 
be  best  to  discuss  its  provisions  under  some  general  heads, 
and  under  each  head  to  include  the  history  of  the  various 
proposals,  as  follows: 

(1)  Control  and  Organization 

(2)  The  Federal  Reserve  Banks 

(3)  The  Note-Issues 

(4)  Disposal  of  the  2  Per  Cent  Bonds 

(5)  Reserves 

(6)  The  Organization  of  Credit 

(7)  Clearings 

(8)  A  Discount  Market 

(9)  Foreign  Banking 

§  2.  Around  the  question  of  organization  and  con- 
trol centred  the  main  antagonism  to  the  plan^  of  the 
National  Monetary  Commission,  which  proposed  a  na- 
tional reserve  association  as  the  means  for  centralizing 
reserves  and  thus  preventing  the  admitted  evil  of  the 
scattering  of  reserves  existent  under  the  old  system.  In 
this  scheme  an  elaborate  organization  was  built  up,  be- 
ginning wath  local  associations  of  banks  which  elected 
directors  for  district  institutions  of  which  there  were  to 
be  fifteen  in  the  whole  Union;  these  fifteen  directorates 
were  to  elect  a  central  governing  body  of  forty-five,  with 
an  executive  committee  of  nine,  in  power  over  the  national 
reserve  association,  of  which  the  fifteen  institutions  were 
to  be  branches.  It  is  to  be  observed  that  the  directors  of 
the  central  body  were  to  be  chosen  by  the  representatives 

'  See  Appendix  II  for  the  plan. 


218  BANKING  PROGRESS 

of  the  banks.  Such  an  institution  was  not,  in  the  usual 
acceptance  of  the  term,  a  central  bank,  because  it  would 
do  no  business  with  the  general  public.  Nevertheless, 
having  one  central  directing  body  elected  by  the  banks, 
opposition  was  raised  against  it  on  the  ground  that  effec- 
tive control  over  it  might  be  obtained  by  ambitious  finan- 
cial groups.  This  opposition  appeared  under  the  so- 
called  "fear  of  Wall  Street."^ 

In  the  original  Glass  Bill,  proposed  by  the  House  com- 
mittee, and  given  out  unofficially  June  17,  1913,  there 
was  proposed  an  entirely  different  system  of  organiza- 
tion and  control.  Instead  of  a  national  reserve  associa- 
tion with  fifteen  branches,  there  was  offered  a  decentral- 
ized organization  of  separate,  incorporated,  regional  Re- 
serve Banks,  in  as  many  districts,  supervised  by  a  Federal 
Reserve  Board,  having  no  capital  and  no  banking  func- 
tions.^ Immediately  attention  was  focussed  upon  the 
composition  and  powers  of  the  Federal  Reserve  Board, 
since  it  was  assumed  that  this  board  would  have  direc- 
tion over  the  general  banking  operations  of  all  the  banks 
in  the  country.  State  or  national,  which  might  enter  the 
new  system.  As  to  its  composition,  the  original  Glass  Bill 
gave  equal  representation  on  the  Federal  Reserve  Board 
to  the  lending  bankers,  the  borrowing  business  public, 
and  the  government.     A  board  of  nine  members  was  to 

^  In  Congress  it  was  emphatically  stated  that,  irrespective  of  the  merits  of  a 
central  bank,  it  could  not  be  proposed  by  Democrats,  because  it  was  forbidden  by 
the  Baltimore  platform.  Cf.  p.  146.  It  is  diflScult  to  reconcile  this  position  with 
that  taken  in  favor  of  abolishing  all  preferences  to  American  coasting-vessels 
going  through  the  Panama  Canal,  which  was  in  direct  opposition  to  the  platform 
of  the  Democratic  party.  The  truth  probably  is  that  political  advantage  was 
gained  by  opposing  a  central  bank.  In  addition,  it  may  well  be  that  regional 
banks  were  better  suited  to  our  conditions. 

*  Mr.  Mann,  the  Republican  leader  in  the  House,  said :  "  So  far  as  we  have 
been  able  to  learn,  the  bill  will  be  in  the  main  pieces  stolen  from  the  Aldrich 
Monetary  Commission  Report,  with  a  few  radical  provisions  taken  from  the 
Bryan  platform  mixed  in.  It  will  be  a  jumble  of  discordant  ideas."  (June  23, 
1913.) 


ll 


THE  FEDERAL  RESERVE  ACT  219 

be  composed  of  (1)  the  secretary  of  the  treasury,  the 
secretary  of  agriculture,  and  the  comptroller  of  the  cur- 
rency, ex  officio;  (2)  three  to  be  chosen  by  the  President 
of  the  United  States,  of  whom  one  would  be  designated 
as  governor,  etc.;  and  (3)  three,  presumably  bankers,  to 
be  chosen  by  the  Federal  Reserve  Banks. 

When  the  bill  prepared  by  the  House  committee 
came  to  be  passed  on  by  Democratic  leaders,  before  it 
was  adopted  as  an  administration  measure,  the  issue  of 
control  became  prominent  and  drew  great  discussion. 
The  administration  demanded  governmental  control  over 
the  banking  system,  urging  that  bankers  per  se  were  the 
ones  to  be  supervised,  and,  therefore,  should  not  control 
the  Federal  Reserve  Board  (any  more  than  railway  men 
should  control  the  Interstate  Commerce  Commission). 
Accordingly,  the  Glass  Bill,  before  being  presented  to  the 
Democratic  caucus  of  the  House,  was  modified  by  chang- 
ing the  number  of  the  board  from  nine  to  seven,  of  whom 
the  two  cabinet  officers  and  the  comptroller  were  to  be 
ex  officio  members,  and  four  others  were  to  be  appointed 
by  the  President,  of  whom  one  (later  changed  to  two) 
should  be  experienced  in  banking.  The  original  bill  pro- 
vided only  that  the  governor  of  the  board  could  be  re- 
moved by  the  President  on  a  statement  of  the  reasons; 
while  in  the  changed  bill  the  President  was  given  power 
of  removal  for  cause  over  the  four  members  appointed 
by  him  for  a  term  of  ten  years.  On  June  23,  1913,  Presi- 
dent Wilson  read  in  person  to  the  extra  session  of  Con- 
gress his  currency  message,  in  which  he  said: 

The  control  of  the  system  of  banking  and  of  issue  which  our 
new  laws  are  to  set  up  must  be  public,  not  private,  must  be 
vested  in  the  government  itself,  so  that  the  banks  may  be  the 
instruments,  not  the  masters,  of  business  and  of  individual 
enterprise  and  initiative. 


220  BANKING  PROGRESS 

As  opposed  to  this  view  the  bankers  held  that  they 
were  obliged  by  the  bill  to  enter  the  system,  or  lose  their 
charters  as  national  banks;  that  a  portion  of  their  capital 
was  "commandeered"  for  the  stock  of  the  new  organiza- 
tions, over  which  they  were  refused  any  control;  that 
such  a  forced  contribution  without  representation  was 
practical  confiscation;  that  such  an  invasion  of  the  gov- 
ernment into  the  realm  of  private  ownership  was  "social- 
istic"; and  that,  in  the  analogy  of  the  Interstate  Commis- 
sion, the  commission  supervises,  but  does  not  pretend 
actually  to  operate,  the  railways,  while  the  Federal  Re- 
serve Board  is  given  direct  control  over  banking  opera- 
tions. The  American  Bankers'  Association,  at  Boston, 
October  8,  1913,  opposed  the  compulsory  contribution 
of  capital  without  representation  on  the  board  as  follows : 

In  return  for  the  capital  thus  appropriated  the  banks  receive 
a  certificate,  which  cannot  be  sold,  assigned,  or  hypothecated, 
over  which  none  of  the  usual  rights  of  property  can  be  exer- 
cised. [National]  banks  are  obliged  to  make  this  subscription, 
or  be  dissolved.  Charters  have  ever  been  regarded  in  the 
nature  of  a  contract,  and  it  is  doubtful  if,  under  our  Constitu- 
tion, Congress  can  take  away  the  charter  of  a  bank  in  this 
summary  manner,  not  because  the  terms  of  the  charter  have 
been  violated  by  the  banks,  but  because  the  bank  management 
might  refuse  to  make  a  coerced  investment  such  as  the  pend- 
ing measure  provides. 

...  If  the  government  can  appropriate  one-tenth  of  a  bank's 
capital  in  the  manner  provided  by  this  bill  this  year,  it 
may  appropriate  one-tenth  the  next  year,  and  so  on  until 
the  capital  is  all  transferred  to  the  government  bank.  If  it 
can  fix  the  compensation  at  5  per  cent  this  year,  it  may  make 
it  4  per  cent  next  year,  and  3  per  cent,  2  per  cent,  1  per  cent — 
a  very  simple  and  easy  process  whereby  the  entire  capital  of  the 
banks  may  be  transferred  to  the  government. 

.  .  .  This  proposition  of  the  government  to  take  the  banks' 
capital  in  the  manner  provided,  carried  to  the  extreme,  would 


THE  FEDERAL  RESERVE  ACT  221 

easily  accomplish,  so  far  as  the  national  banks  are  concerned, 
this  contention  on  the  part  of  the  SociaUsts.  For  those  who  do 
not  believe  in  Socialism  it  is  very  hard  to  accept  and  ratify 
this  proposed  action  on  the  part  of  the  government. 

To  the  bankers  political  control  by  appointees  of  the 
President,  without  banking  experience,  meant  incom- 
petent management.  Consequently,  they  urged  that 
three  members  of  the  board  should  be  elected  by  the 
directors  of  the  Federal  Reserve  Banks. 

Thus  was  the  issue  joined  between  government  super- 
vision and  banking  control.  It  is  now  obvious  that  the 
issue  hinged  on  the  powers  granted  to  the  Federal  Reserve 
Board.  If  actual  banking  operations  are  carried  on, 
not  by  the  Reserve  Board  but  by  the  directors  of  the  re- 
spective Reserve  Banks,  a  majority  of  whose  directors 
are  chosen  by  the  member  banks,  the  question  at  issue 
practically  disappears.     What,  then,  are  these  powers  .^^ 

In  Sec.  11  are  enumerated  the  powers  of  the  Federal 
Reserve  Board: 

(a)  To  examine,  and  require  weekly  statements  of,  reserve 
and  member  banks. 

(6)  To  permit,  or  by  a  vote  of  five  members  to  require,  one 
Federal  Reserve  Bank  to  rediscount  for  another,  and  to  fix  the 
rate  of  discount  charged  in  such  a  case. 

(c)  To  suspend  reserve  requirements  for  not  more  than  thirty 
days,  provided  a  tax  is  imposed  on  Reserve  Banks  should  re- 
serves fall  below  a  certain  percentage. 

(d)  To  supervise  the  issue  and  retirement  of  Federal  Reserve 
notes. 

(e)  To  add  to,  or  reclassify,  existing  reserve  or  central  re- 
serve cities. 

if)  To  remove  for  cause  any  oflScer  or  director  of  any  Reserve 
Bank. 

(fif)  To  require  Reserve  Banks  to  write  off  worthless  assets. 
(h)  To  suspend  any  Reserve  Bank  for  violations  of  this  act. 


222  BANKING  PROGRESS 

(i)  To  safeguard  all  collateral,  notes,  etc.,  deposited  with 
its  agents;  and  to  make  all  rules  necessary  to  enable  the  Board 
to  perform  the  duties,  functions,  or  services  of  this  act. 

(j)  To  exercise  general  supervision  over  Reserve  Banks. 

(k)  To  permit  national  banks  to  act  as  trustee,  executor, 
etc.,  and  estabhsh  rules  therefor. 

(/)  To  employ  experts,  assistants,  clerks,  etc.,  and  fix  their 
salaries  and  fees. 

Besides  the  grant  of  these  specific 'powers,  additional 
powers^  were  granted  in  other  sections  throughout  the 
act  as  follows: 

1.  To  readjust  Federal  Reserv^e  districts  (sec.  2). 

2.  To  regulate  the  establishment  of  branch  banks  within 
the  respective  Federal  Reserve  districts,  and  appoint  three 
directors  for  each  branch  (sec.  3), 

3.  To  designate  three  members  (Class  C)  for  each  Federal 
Reserve  Bank,  one  to  be  chairman  of  the  board  and  known 
as  the  "Federal  Reserve  Agent";  and  to  secure  impartial 
treatment  to  each  member  bank  (sec.  4). 

4.  To  call  at  discretion  the  unpaid  half  of  capital  stock; 
to  determine  the  amounts  returned  to  a  bank  withdrawing 
from  membership  (sec.  5);  and  to  pass  on  the  amount  of  any 
reduction  of  capital  (sec.  28). 

5.  To  pass  on  applications  for  membership  from  state  banks, 
and  to  estabhsh  by-laws  therefor;  to  prescribe  rules  enforcing 
requirements  of  this  act  (sec.  9), 

6.  To  require  a  member  bank  to  surrender  its  stock,  if  it 
fails  to  comply  with  the  law  or  rules  of  the  Board  (sec.  9). 

7.  To  levy  on  the  Reserve  Banks  a  semi-annual  assessment 
to  cover  the  expenses  of  the  Board  (sec.  10). 

8.  To  have  general  supervision  over  the  Bureau  of  the  Comp- 
troller of  the  Currency  (sec.  10). 

9.  To  make  an  annual  report  to  the  Speaker  of  the  House  of 
Representatives  (sec.  10). 

10.  To  approve  salaries  and  allowances  granted  to  members 

*  Cf.  Report  of  House  Committee  on  Banking  and  Currency,  September  9,  1913, 
No.  69,  Sixty-third  Congress,  1st  session,  pp.  46-47. 


THE  FEDERAL  RESERVE  ACT  223 

of  Advisory  Council;  and  to  call  meetings  of  said  Council  (sec. 

11.  To  define  the  character  of  the  paper  eligible  for  redis- 
count by  Reserve  Banks;  and  to  regulate  discounts  by  said 
banks  of  bills  receivable,  bills  of  exchange,  and  acceptances 
(sec.  13). 

12.  To  fix  the  percentage  to  the  capital  of  a  Reserve  Bank 
which  limits  the  discounts  of  agricultural  paper  having  a  ma- 
turity of  not  over  six  months  (sec.  13). 

13.  To  establish  rules  for  dealings  in  cable  transfers,  accep- 
tances, and  bills  of  exchange,  or  in  securities  of  the  United  States, 
or  subdivisions  thereof,  by  Reserve  Banks  (sec.  14). 

14.  To  review  rates  of  discount  charged  by  Reserve  Banks 
(sec.  14). 

15.  To  pass  on  applications  of  Reserve  Banks  wishing  to 
engage  in  foreign  operations  (sec.  14  (e)). 

16.  To  issue  at  discretion  Federal  Reserve  notes  to  Reserve 
Banks  on  deposit  of  an  equal  amount  of  collateral  security; 
to  call  for  additional  security  therefor;  to  assign  a  distinctive 
letter  and  serial  number  for  notes  issued  by  the  respective 
Reserve  Banks;  to  require  each  Reserve  Bank  to  maintain 
at  the  United  States  Treasury  a  gold  reserve  (not  less  than  5 
per  cent)  for  its  own  notes;  to  grant  or  to  reject  any  applica- 
tion for  notes;  to  establish  the  rate  of  interest  to  be  paid  for 
such  notes;  to  make  rules  allowing  substitutions  of  collateral 
behind  the  notes;  and  to  charge  Reserve  Banks  with  all  ex- 
penses due  to  printing,  issue,  and  retirement  of  such  notes 
(sec.  16). 

17.  To  fix  charges  for  checks  cleared  through  Reserve  Banks 
and  for  transfer  of  funds  among  said  banks  (sec.  16). 

18.  To  establish  at  its  discretion  a  Clearing  House  for  Re- 
serve Banks,  or  one  for  member  banks  (sec.  16). 

19.  To  require  Reserve  Banks  to  purchase  United  States 
bonds  when  member  banks  give  them  up  to  withdraw  circula- 
tion, according  to  a  given  allotment  (sec.  18). 

20.  To  grant  approval  of  refunding  of  2  per  cents  into  3 
per  cents  by  the  Secretary  of  the  Treasury  and  Reserve  Banks 
(sec.  18). 

21.  To  permit  a  non-member  to  obtain  discounts  from  a 
Reserve  Bank  through  a  member  bank;   to  allow  the  reserve 


224  BANKING  PROGRESS 

of  a  member  bank  with  its  Reserve  Bank  to  be  drawn  upon 
under  penalties;  and  to  allow  national  banks  in  Alaska  and 
outside  the  continental  United  States  (except  the  Philippines) 
to  join  a  reserve  district  (sec.  19). 

£2.  To  examine  member  banks;  to  accept  in  some  cases 
examinations  of  member  banks  by  state  authorities;  to  fix 
salaries  of  examiners  (instead  of  the  present  fee  system);  to 
permit  special  examinations;  to  demand  information  from  a 
Reserve  Bank  at  any  time  regarding  a  member  bank;  to  order 
an  examination  of  each  Reserve  Bank  at  least  once  a  year 
(sec.  21). 

23.  To  add  to  the  list  of  cities  in  which  national  banks  are 
not  permitted  to  loan  on  real  estate  (sec.  24). 

24.  To  approve  or  reject  applications  of  national  banks  to 
establish  foreign  branches,  and  to  order  examinations  of  said 
branches  (sec.  25). 

25.  To  force  a  national  bank  to  cease  to  act  as  a  reserve  agent, 
if  it  did  not  enter  the  system  within  60  days  after  the  act  was 
passed  (sec.  2). 

A  study  of  these  powers  of  the  board  shows  that  they 
are  mainly  supervisory  or  administrative  after  the  gen- 
eral example  of  the  powers  of  the  comptroller  of  the  cur- 
rency over  national  banks.  In  a  few  respects,  however, 
it  may  be  said  that  the  board  has  more  than  supervisory 
powers. 

In  Sec.  11  (b)  and  (c)  the  board  is  given  power  to  re- 
quire one  Reserve  Bank  to  discount  for  another,  and  to 
suspend  reserve  requirements  (for  member  banks  as  well 
as  Reserve  Banks)  for  not  more  than  thirty  days.  This 
latter  power,  to  be  sure,  has  been  exercised  in  effect  by 
the  comptroller's  discretion  in  not  closing  a  bank  whose 
reserves  were  below  the  legal  limit.  In  making  general 
definitions  regarding  eligible  paper  for  discount  (Sec.  13), 
the  action  of  the  board  is  still  in  the  main  supervisory. 
Moreover,  it  has  only  powers  of  review,  not  initiative, 
over  the  rate  of  discount  set  by  the  respective  Reserve 


THE  FEDERAL  RESERVE  ACT  225 

Banks  (Sec.  14).  Also,  tlie  board  may  reject  applica- 
tions from  Reserve  Banks  for  notes,  but  probably  this 
authority  is  only  to  be  exercised  in  order  to  restrict  un- 
healthy expansion,  or  because  the  collateral  was  unde- 
sirable, and  the  like.  In  regard  to  establishing  a  system 
of  clearings  (Sec.  16),  however,  the  board  has  powers  of 
initiative  which  are  certainly  more  than  merely  super- 
visory, touching  not  only  the  earnings,  but  the  existing 
methods  of  business  of  member  banks.  Also  quite  as 
important  as  any  is  the  power  to  suspend  any  officer  or 
director  of  any  Reserve  Bank  (Sec.  11  (/)),  which  means 
obviously  any  director  elected  by  the  banks  as  well  as 
its  own  appointees.  Yet  it  is  to  be  observed  that  in  no 
case  is  the  board  empowered  to  conduct  strictly  banking 
operations  of  discount  and  deposit. 

On  the  other  hand,  as  distinctly  opposed  to  the  Federal 
Reserve  Board,  stand  the  Federal  Reserve  Banks,  to 
whom  are  given  all  strictly  banking  functions  of  discount, 
deposit,  and — in  a  practical  sense — issue.  While  the 
bill  was  in  the  hands  of  the  Senate  committee  an  attempt 
was  made,  and  supported  by  the  Republican  minority, 
to  give  direct  banking  powers  to  the  Reserve  Board,  thus 
creating  a  type  of  central  bank.  Fortunately,  this  pro- 
posal failed.  Consequently,  the  success  of  the  new  system 
must  depend  for  its  essential  banking  operations  on  the 
managements  of  the  respective  Reserve  Banks. 

As  regards  the  general  question  of  control,  it  is  to  be 
noted  that  there  is  a  distinction  to  be  made  between 
governmental  and  political  control.  There  may  be  gov- 
ernmental supervision  and  direction  through  the  Reserve 
Board  which  is  not  political,  provided  the  board  is  not 
governed  by  political  motives  in  its  action.  Appoint- 
ment of  members  of  the  board  by  the  President  should 
not  mean  political  management  any  more  than  in  the 


226  BANKING  PROGRESS 

case  of  the  supervision  exercised  by  the  comptroller  of 
the  currency  over  national  banks  in  the  past;  or  any 
more  than  presidential  appointment  of  judges  means 
political  decisions  on  the  law.  More  than  this,  it  is  to 
be  kept  in  mind  that  the  control  of  discounts  and  de- 
posits, the  primary  functions  in  a  banking  system,  is 
placed  in  the  hands  of  the  boards  of  the  respective  Re- 
serve Banks,  the  majority  of  whom  are  elected  by  mem- 
ber banks,  and  who  should  be  men  of  practical  banking 
experience.  Thus,  while  there  is  governmental  super- 
vision by  the  Reserve  Board,  as  above  described,  all 
questions  of  discounts  and  use  of  deposits,  in  the  daily 
round  of  business,  are  left  to  technical  bankers. 

As  to  the  possibility  of  changing  the  political  character 
of  the  Reserve  Board,  let  us  assume  that  President  Wilson 
were  succeeded  by  a  Republican  on  March  4,  1917.  The 
board  was  being  appointed  in  (say)  April,  1914.  Then 
the  term  of  the  member  appointed  for  four  years  would 
expire  in  April,  1918;  and  of  the  one  for  six  years,  in 
April,  1920.  Hence  both  of  these  positions,  in  addition 
to  the  appointment  of  the  secretary  of  the  treasury,  might 
be  filled  by  a  new  President.  The  term  of  office  of  the 
comptroller  of  the  currency,  appointed  in  1914,  being 
five  years,  his  successor  would  be  named  by  a  new  Presi- 
dent. Thus  a  majority  of  the  board  (four  out  of  seven) 
could  be  reconstituted  in  the  term  of  the  next  President. 

The  co-ordinating  influence  of  a  supervisory  board  will 
go  far  to  remedy  the  scattering  of  reserves  formerly  so 
great  an  evil;  to  establish  continuity  of  policy;  to  gain 
co-operation  between  all  the  banks  represented  in  the 
Reserve  Banks;  to  check  trouble  in  one  district  before 
it  has  extended  to  another;  and,  without  the  dreaded 
centralization,  to  have  federation  with  local  government 
in  each  district.     Already  concentration,  without  legal 


THE  FEDERAL  RESERVE  ACT  227 

regulation,  had  appeared,  but  it  had  not  prevented  scat- 
tering of  reserves,  nor  an  individualistic  condition  of 
bankir^  (very  far  from  the  common  control  that  had 
been  so  much  feared).  The  legal  creation  of  a  central 
body  which  could  have  been  captured  and  used  would 
have  been  a  very  much  more  dangerous  thing.  Regional 
banks,  each  sovereign  in  its  own  district  as  regards  dis- 
counts, have  probably  removed  this  danger  forever. 
Moreover,  the  Federal  Advisory  Council,  one  member 
chosen  respectively  by  each  Reserve  Bank,  gives  the 
board  a  nexus  with  conditions  in  all  parts  of  the  Union, 
and  by  the  publicity  of  its  opinions  should  exercise  an 
influence  proportionate  to  the  soundness  of  its  judgment. 

§  3.  The  legislative  struggles  gathered  mainly  about 
this  question  of  central  control.  The  nice  point  in  the 
result  was  the  right  adjustment  of  the  powers  of  the 
over-board  as  compared  with  those  of  the  Reserve  Banks. 
Here  was  the  need  of  high  legislative  skill  as  well  as  of 
practical  banking  insight.  The  outcome  is  remarkable. 
It  would  have  been  easy  to  go  too  far  in  either  direction. 
On  the  one  hand,  due  to  a  current  belief  that  a  control 
over  credits  was  possessed  by  the  larger  banks  of  New 
York  City,  there  were  manj'-  who  regarded  government 
control  of  banking  credits  as  the  only  means  for  securing 
equality  of  treatment.  This  attitude  was  a  part  of  the 
present-day  tendency  to  press  for  increasing  govern- 
mental interference  with  trade  and  industry.  While 
there  was  opposition  to  a  central  bank  of  private  capital 
and  of  private  management,  there  was  more  or  less  sup- 
port for  a  central  bank  owned  and  controlled  by  the  gov- 
ernment. Thus,  although  there  was  a  well-preserved 
tradition  in  the  Democratic  ranks  (based  on  ignorance 
of  the  real  services  of  the  Second  United  States  Bank,  and 


228  BANKING  PROGRESS 

which  did  them  little  credit)  against  a  central  bank,  and 
although  Democrats  were  supposed  to  dislike  a  centrali- 
zation of  political  power,  yet  the  opposition  to  the  plan 
of  the  National  Monetary  Commission  was  clearly  due, 
not  so  much  to  fear  of  a  central  bank,  as  to  the  fear  of  a 
privately  capitalized  central  institution  which  might  be 
controlled  by  the  "interests." 

On  the  other  hand,  sensible  men  of  all  parties  realized 
that  it  would  be  impracticable  to  allow  government  oflB- 
cials,  often  political  appointees,  to  do  the  actual  work 
of  technical  banking,  to  grant  loans,  to  manage  resources 
and  investments — in  short,  to  introduce  the  government 
into  the  banking  business.  Political  control  was  obvi- 
ously as  dangerous  as  private  financial  control;  and  it 
would  have  been  destructively  inefficient. 

The  solution  of  the  matter  finally  adopted  was,  inter- 
estingly enough,  centralization  by  districts;  that  is,  a 
centralization  intended  to  prevent  scattering  of  reserves 
was  obtained  by  establishing  in  each  district  an  mstitu- 
tion  itself  quite  similar,  in  powers  within  its  jurisdiction, 
to  the  national  reserve  association  of  the  Monetary 
Commission.  That  is,  the  government  was  saved  from 
going  into  the  banking  business  by  granting  local  cen- 
tralization with  capital  and  management  supplied  by 
the  banks,  and  yet  federated  under  a  common  authority 
in  order  to  establish  governmental  direction  and  unity 
of  purpose.  In  its  essence  this  plan  retained  the  work- 
ings of  local  self-government,  together  with  the  operation 
of  technical  banking  by  those  who  supplied  the  capital, 
but  under  general  direction.  This  final  adjustment 
which  secured  safe  and  efficient  methods,  as  contrasted 
with  the  chaotic  proposals  which  might  have  been  adopted, 
should  be  a  cause  of  permanent  congratulation.  The 
nice  balancing  of  powers  between  governmental  super- 


THE  FEDERAL  RESERVE  ACT  229 

vision  and  technical  banking  also  appears  in  not  going 
too  far  in  local  decentralization  as  illustrated  in  the  de- 
velopment of  our  clearing-house  operations.  In  these, 
because  of  the  absence  of  any  legal  aids,  local  clearing- 
houses had  been  granting  efficient  banking  service  in 
times  of  panic,  but  in  an  isolated,  unco-operative  manner. 
Detachment  went  to  extremes;  each  clearing-house  was 
working  without  efficiency,  because  working  by  itself. 

It  is  to  be  observed,  moreover,  that  the  solution  adapted 
to  our  conditions,  in  which  a  widely  scattered  system  of 
individual  banks  had  to  be  retained,  must  be  original 
with  us.  In  no  other  country  were  the  conditions  the 
same.  The  relation  of  a  central  bank  in  European  states 
to  other  banlvs  was  not  one  based  on  the  existence  of  a 
system  of  individualistic  and  numerous  banks  carrying 
on  independent  operations.  Therefore,  while  retaining 
self-management  of  privately  owned  banks,  co-operation 
was  obtained  by  Reserve  Banks  in  local  districts  under 
management  by  bankers,  while  country-wide  and  uni- 
form action  was  gained  by  governmental  direction  through 
a  Federal  Reserve  Board. 

The  difficulty  of  sectional  differences  of  interest  work- 
ing against  each  other  would,  nevertheless,  have  to  be 
met  in  the  practical  workings  of  any  plan.  If  there  had 
been  one  central  institution,  pressure  would  have  been 
brought  upon  the  central  management  to  help  out  one 
section  of  the  country  at  the  expense  of  another.  Under 
a  system  of  regional  banks,  each  section  gets  the  support 
of  its  own  resources  first  of  all,  an  arrangement  by  which 
sectional  antagonism  is  reduced  to  the  minimum.  In 
addition,  when  one  section  is  in  trouble  beyond  its  own 
powers  of  recovery,  then  by  aid  of  the  Reserve  Board, 
one  Reserve  Bank  may  come  to  the  aid  of  another. 
Such  a  practice,  it  is  to  be  noted,  had  been  going  on  in 


230  BANKING  PROGRESS 

an  extralegal  way  in  previous  years  whenever  the  banks 
of  a  large  centre  sought  assistance  from  New  York. 
Such  a  practice  was  natural  and  inevitable.  In  the  new 
law  such  practice  is  openly  recognized  and  legalized.  It 
is,  in  effect,  the  same  kind  of  action  asked  for  by  one 
borough,  whose  protective  equipment  has  been  taxed 
to  excess  by  fire  when  it  seeks  the  aid  of  another  borough, 
not  so  threatened. 

A  Federal  Reserve  Bank  is  to  be  established  in  each  of 
at  least  eight,  and  in  not  more  than  twelve,  districts, 
"apportioned  with  due  regard  to  the  convenience  and 
the  customary  course  of  business"  in  the  continental 
United  States,  excluding  Alaska  (Sec.  2).  This  was  to 
be  done  by  the  organization  committee,  who  have  since 
agreed  on  twelve.  Not  only  existing  business  and  trans- 
portation relations  must  be  considered,  but  also  the  nature 
of  the  industries,  in  order  that  all  the  resources  of  a  dis- 
trict should  not  be  invested  in  only  one  kind  of  paper 
presented  at  the  same  time.  Obviously  delimitations  of 
districts  may  seem  geographically  curious,  but  yet  be 
industrially  correct. 

Each  Reserve  Bank  will  perform  all  the  general  func- 
tions of  a  tjT^ical  bank,  and  its  powers  may  briefly  be 
enumerated  as  follows: 

1.  To  incorporate,  have  succession  for  20  years,  and  sue  and 
be  sued  (sec.  4). 

2.  To  appoint  its  own  employees  (sec.  4). 

3.  To  have  all  the  special  powers  granted  in  this  act,  and  all 
those  incidental  to  carrying  on  its  business  of  banking  (sec.  4). 

4.  To  have  a  capital  of  not  less  than  $4,000,000  (sec.  2).  ' 

5.  To  establish  branches  in  its  district,  and  designate  four 
of  the  seven  branch  directors  (sec.  3). 

6.  To  pay  dividends  on  stock,  if  earned  (sec.  7). 

7.  To  determine  the  relative  amount  of  credit  granted  to 
each  bank  (sec.  4). 


THE  FEDERAL  RESERVE  ACT  231 

8.  To  obtain  circulating  notes  after  the  manner  of  national 
banks  in  the  interim  before  Reserve  notes  supersede  national 
bank  notes  (sees.  4,  18). 

9.  To  provide  compensation  for  directors  (sec.  4). 

10.  To  be  exempt  from  taxation  (sec.  7). 

11.  To  elect  a  member  of  the  Advisory  Council  (sec.  12). 

12.  To  pass  on  all  discounts  allowed  by  this  act  to  member 
banks  (sec.  13). 

13.  To  fix  the  rate  of  discount  to  member  banks  (sec.  14). 

14.  To  receive  deposits  from  the  Treasury  or  member  banks, 
if  it  keeps  35  per  cent  reserves  in  gold  or  lawful  money  (sees. 
13,  16). 

15.  To  hold  deposits  from,  and  open  accounts  with,  other 
Reserve  Banks  for  exchange  purposes  (sees.  13,  14). 

16.  To  buy  and  sell  in  the  open  market  bankers'  acceptances 
and  bills  (sec.  14). 

17.  To  deal  in  gold  coin  at  home  and  abroad;  to  borrow  gold 
on  security  of  government  bonds,  etc.  (sec.  14). 

18.  To  buy  and  sell  at  home  and  abroad  government  securi- 
ties, bills,  notes,  revenue  warrants,  etc.  (sec.  14). 

19.  To  maintain  agencies,  correspondents,  and  banking  ac- 
counts abroad  for  dealings  in  bills  of  exchange  (sec.  14). 

20.  To  receive  government  deposits,  and  act  as  fiscal  agent 
for  the  United  States  (sec.  15). 

21.  To  present  commercial  collateral  and  obtain  Federal 
Reserve  Notes,  if  it  holds  a  40  per  cent  reserve  in  gold  for  them 
(sec.  16). 

22.  To  receive  at  par  checks  on  member  banks  (sec.  16). 

23.  To  become  a  clearing-house  for  its  district  (sec.  16). 

24.  To  join  in  purchasing  not  over  $25,000,000  per  annum 
of  United  States  bonds  securing  circulation,  in  allotments  desig- 
nated by  the  Reserve  Board  (sec.  18). 

25.  To  have  2  per  cent  bonds  refunded  into  3  per  cents 
(sec.  18). 

26.  To  examine  member  banks  and  their  foreign  branches 
(sec.  21). 

From  this  exposition  it  will  be  seen  that  each  Federal 
Reserve  Bank  is  to  perform  all  the  fundamental  banking 
functions  of  issue,  discount,  and  deposit;    but  that  it  is 


232  BANKING  PROGRESS 

a  bank  for  banks,  and,  with  some  exceptions  to  be  noted 
later,  not  a  bank  for  the  public.  Viewed  from  the  stand- 
point of  correcting  existing  evils  in  our  banking  and  cur- 
rency system,  it  will  be  found,  from  our  later  discussion, 
that  the  Federal  Reserve  Banks  are  established  for  the 
purpose  of  providing  (1)  through  the  issue-function  an 
elastic  currency;  (2)  through  the  discount-function  the 
much-needed  elasticity  of  credit  by  a  reorganization  of 
our  credit  structure;  and  (3)  through  the  deposit-func- 
tion an  effective  mobilization  of  bank  reserves  to  secure 
co-operation  in  times  of  stress;  and  (4)  the  abolition  of 
the  antiquated  independent  treasury  system.  More 
than  that,  a  possibility  of  an  extension  of  the  clearings- 
functions  seems  to  open  up. 

These  facts  disclose  clearly  that  the  Reserve  Banks 
form  the  backbone  of  the  whole  system,  and  that  its  suc- 
cess will  depend  directly  upon  their  management.  Here 
is  the  crux  of  the  whole  matter.  Upon  the  directors  of 
these  banks  lies  the  heaviest  responsibility  arising  from 
the  new  law.  It  is  very  much  to  be  doubted  if  legislators 
or  the  public  realize  the  practical  diflSculty  of  finding  the 
men  competent  to  assume  this  responsibility,  and  of  in- 
suring a  sound,  intelligent,  skilled,  and  judicious  manage- 
ment. Consequently,  the  methods  of  choosing  the  di- 
rectors and  officials  are  of  first  importance.  The  nine 
directors  of  each  Reserve  Bank  have  a  term  of  three  years, 
and  are  divided  into  three  classes.  A,  B,  and  C  (Sec.  4). 
The  three  members  of  Class  A  are  supposedly  to  be 
bankers,  and  are  chosen  by  the  member  banks  of  the 
district.  The  directors  of  each  member  bank  choose 
one  elector;  from  the  total  list  of  persons  nominated, 
one  by  each  bank,  the  electors  are  to  choose  the  three 
directors  of  Class  A.  At  the  same  time  and  by  the  same 
electors,  three  directors  for  Class  B  are  to  be  chosen  in 


THE  FEDERAL  RESERVE  ACT  233 

the  same  way,  who  shall  be  men  actively  engaged  In  com- 
merce, agriculture,  or  industry  within  the  district.  The 
Reserve  Board  appoints  the  three  members  of  Class  C, 
who  shall  have  been  residents  of  the  district  for  at  least 
two  years,  and  one  of  whom  shall  be  designated  as  chair- 
man of  the  board  of  directors  and  also  as  the  "Federal 
Reserve  Agent."  In  short,  the  constituent  banks  have 
the  power  to  choose  more  than  a  majority  (six)  of  the 
nine  directors  of  each  Reserve  Bank,  while  the  represen- 
tative of  the  Reserve  Board  is  always  present.  By  this 
arrangement,  technical  banking  operations  are  relegated 
to  the  Reserve  Banks,  and  the  responsibility  for  good  or 
bad  management  is  placed  on  the  banks  themselves,  on 
the  men  whom  they  have  elected.  In  choosing  the  di- 
rectors of  Classes  A  and  B,  the  member  banks  are  to  be 
divided  into  three  general  groups;  "each  group  shall  con- 
tain as  nearly  as  may  be  one-third  of  the  aggregate 
number  of  the  member  banks  of  the  district  and  shall 
consist,  as  nearly  as  may  be,  of  banks  of  similar  capitaliza- 
tion" (Sec.  4).i 

Much  discussion  was  also  had  on  the  most  desirable 
number  of  Reserve  Banks.  Irrespective  of  banking  con- 
siderations, to  politicians  it  was  of  course  imperative  to 
have  one  in  each  congressional  "deestrict."  To  believers 
in  a  central  bank,  it  was  supposed  that  a  small  number, 
like  four,  could  be  made  to  work  like  one.  The  desire 
for  decentralization,  however,  forced  a  larger  number. 
But  it  was  a  mistake  to  fix  upon  any  definite  number  at 
the  outset.  It  would  have  been  better  to  have  started 
with  the  three  central  reserve  cities  (New  York,  Chicago, 
and  St.  Louis),  having  "regard  to  the  convenience  and 

^Section  4  was  amended  June  21,  1917,  and  September  26,  1918.  The  di- 
vision of  groups  into  one-third  the  aggregate  number  was  dropped,  and  the 
procedure  of  election  simplified. 


234  BANKING  PROGRESS 

customary  course  of  business,'*  and  to  have  given  the 
Reserve  Board  power  to  increase  the  number  of  districts 
as  time  and  experience  demanded.  In  the  working  of 
the  law  as  it  stands,  we  shall  probably  have  another 
illustration  of  the  impossibility  of  legislation  to  change 
materially  the  natural  tendencies  of  trade.  The  Reserve 
Bank  in  New  York  City  will  be  the  largest  and  most  in- 
jfluential  because  the  banking  capital  and  trade  of  New 
York  City  is,  and  will  remain,  the  largest.  In  times  of 
stress  other  parts  of  the  country  will  continue  to  some 
extent  to  go  to  New  York  or  Chicago  for  help,  solely  be- 
cause it  is  the  place  where  help  can  be  had.  Yet,  apart 
from  these  considerations,  it  should  not  be  forgotten 
that  the  mere  size  of  the  capital  of  a  bank  is  no  measure 
of  its  lending  power.  In  neither  men  nor  banks  is  size 
a  warrant  of  virtue.  The  quality  of  its  management,  the 
amount  of  its  deposits,  the  character  of  its  discounts  are 
all  of  more  importance  to  the  efficiency  of  a  Reserve  Bank 
than  the  amount  of  its  capital. 

So  marked  a  departure  from  our  past  banking  institu- 
tions and  practices  as  is  involved  in  the  new  law  is  cer- 
tain to  encounter  obstacles.  The  very  existence  of  dis- 
counts, and  earnings  thereon,  in  a  Reserve  Bank  depends 
upon  the  rediscounting  of  paper  received  in  the  course 
of  business  by  member  banks  who  wish  to  get  assistance 
from  a  Reserve  Bank;  and  yet  rediscounting  has  been 
generally  regarded  in  this  country  as  suspicious,  or  as  an 
evidence  of  weakness.  The  practical  underhanded  de- 
vices by  which  the  need,  indicated  by  rediscounting,  has 
been  actually  met  in  the  past  would  be  wholly  unneces- 
sary under  the  new  act.  Obviously,  if  banks  of  high 
standing  and  strength  have  recourse,  as  they  undoubt- 
edly will,  to  rediscounting  paper  at  a  Reserve  Bank,  any 
small  bank  can  do  the  same  without  casting  suspicion 


THE  FEDERAL  RESERVE  ACT  235 

upon  its  condition.  What  is  normal  and  usual  will  cease 
to  excite  comment.  But  since  rediscounting  has  been 
resorted  to  in  the  past  only  when  it  was  desired  to 
strengthen  a  bank's  reserves,  it  has  been  held  by  some 
experienced  bankers  that  recourse  to  the  Reserve  Banks 
for  rediscounts  will  be  had  only  in  times  of  stringency,  and 
that  in  normal  conditions  of  trade  the  Reserve  Banks 
will  do  little  business.^ 

In  anticipation  of  inactive  funds,  provision  has  been 
made  to  allow  the  Reserve  Banks  to  engage  in  certain 
open-market  operations.  It  is  understood,  of  course, 
that  it  was  expected  these  banks  would  discount  only 
for  member  banks,  and  not  for  the  public  (except  as  later 
explained).  The  power  to  invest  idle  funds  permits 
dealings  at  home  or  abroad  in  bonds  and  notes  of  the 
United  States,  and  bills,  notes,  revenue  bonds,  and  war- 
rants maturing  in  not  over  six  months  to  anticipate 
revenues  of  any  State  or  other  division  of  the  United 
States,  or  of  irrigation,  drainage,  or  reclamation  districts 
(Sec.  14).  Such  dealings  are  to  be  carried  on  under  rules 
of  the  Reserve  Board,  but  the  power  is  wide.  Under 
"bills"  is  included,  no  doubt,  "bills  receivable,"  as  men- 
tioned in  the  section  preceding  (Sec.  13).  Such  bills,  as 
well  as  domestic  bills  of  exchange,  acceptances  author- 
ized by  this  act,  cable  transfers,  bankers'  acceptances, 
and  bills  of  exchange  "of  the  kinds  and  maturities  by 
this  act  made  eligible  for  rediscount,  with  or  without 
the  indorsement  of  a  member  bank"  may  be  bought  and 
sold  "either  from  or  to  domestic  or  foreign  banks,  firms, 
corporations,  or  individuals"  by  a  Reserve  Bank  (Sec. 

^Any  hesitation  as  to  rediscounting  was  entirely  overcome  diuring  the  Eu- 
ropean War.  In  fact,  the  Federal  Reserve  Banks  were  pushed  to  the  limit  in 
carrjTng  our  government  loans.  So  far  did  it  go  that  the  system  could  no 
longer  be  regarded  as  a  recourse  in  any  additional  emergency.  Cf.  Chapter 
XI.  §9. 


236  BANKING  PROGRESS 

14).  Here  we  have  a  surprisingly  large  departure  from 
the  limitation  of  business  to  member  banks.  It  seems  to 
suggest  large  possibilities  of  dealings  with  the  public, 
if  the  paper  is  in  the  form  of  bills  of  exchange,  etc.  It  is 
much  to  be  doubted  if  the  effect  of  these  provisions  has 
been  fully  foreseen. 

As  regards  dealing  in  public  securities,  or  foreign  bills 
of  exchange,  there  can  be  little  question;  but  it  is  to  be 
noted  that  dealings  in  the  securities  of  foreign  govern- 
ments are  not  included.  It  was  urged  in  behalf  of  a 
central  bank  that  it  was  necessary  to  the  maintenance 
of  a  sufficient  fund  of  gold;  and  the  experience  of  the 
Bank  of  France  was  an  obvious  example  of  what  might 
be  done.  It  is  to  be  determined  whether  twelve  Reserve 
Banks  can  preserve  our  gold  supply  as  well  as  one  central 
institution,  or  as  it  was  done  through  New  York  in  the 
past  voluntarily.  Very  much  can,  of  course,  be  done  to 
regulate  the  international  flow  of  gold  by  skilful  dealings 
in  foreign  exchange;  but  here  we  may  have  no  unified 
action.  On  the  other  hand,  we  are  a  gold-producing 
country;  and  the  Reserve  Banks  can  start  with  strong 
gold  reserves  behind  their  liabilities.  Yet,  apart  from 
expected  movements  of  gold  on  a  considerable  scale,  we  . 
must  face  the  possibility  of  a  great  and  unexpected  emer- 
gency. It  is  well  known  that  in  the  past  we  have  had 
no  official  institution  capable  of  negotiating  for  gold 
with  the  great  European  banks.  Will  a  separate  Reserve 
Bank  be  regarded  as  satisfactory.'*  Perhaps  the  New 
York  Reserve  Bank  will  be  the  one  large  enough  to  be 
relied  on.  However  that  may  be,  each  Reserve  Bank  is 
given  specific  power  "to  deal  in  gold  coin  and  bullion  at 
home  or  abroad"  and  "to  contract  for  loans  of  gold  coin 
or  bullion,  giving  therefor,  when  necessary,  acceptable 
security,  including  the  hypothecation  of  United  States 


THE  FEDERAL  RESERVE  ACT  237 

bonds  or  other  securities  which  Federal  Reserve  banks 
are  authorized  to  hold"  (Sec.  14).  Here  will  come  in 
the  suitability  of  the  one-year  3  per  cent  notes  not  having 
the  circulation  privilege  given  in  exchange  for  2  per  cent 
bonds  having  the  circulation  privilege  (Sec.  18). 

§  4.  Apart  from  the  effect  of  the  Federal  Reserve 
Act  of  1913  on  our  credit  system,  its  relations  to  our 
currency  system  will  have  special  interest  to  the  general 
public,  notably  to  those  who  have  been  concerned  with 
the  struggles  over  government  issues  and  free  silver. 
For  a  long  time  this  country  had  been  facing  a  decision 
on  the  question  whether  the  forms  of  money  (irrespec- 
tive of  the  standard,  be  it  gold  or  silver)  needed  as  media 
of  exchange  in  the  daily  round  of  business  should  be 
issued  by  the  government,  after  the  example  of  the  United 
States  notes  (i.  e.,  greenbacks),  or  by  the  banks,  after 
the  example  of  national  bank  notes. ^  In  order  to  deter- 
mine the  bearing  of  the  new  law  on  this  general  ques- 
tion, a  statement  of  the  provisions  regarding  note-issues 
will  first  be  given. 

No  change  is  made  in  regard  to  any  of  the  following 
forms  of  money:  gold,  gold  certificates,  silver,  silver  cer- 
tificates, and  United  States  notes.  Indeed,  all  past  ques- 
tions touching  the  standard  were  definitely  settled  by  a 
remarkable  amendment  in  the  House,  now  embodied  in 
Sec.  26  of  the  new  act,  which  emphasized  the  mainte- 
nance of  the  gold  standard: 

Nothing  in  this  Act  contained  shall  be  construed  to  repeal 
the  parity  provision  or  provisions  contained  in  an  Act  approved 
March  fourteenth,  nineteen  hundred,  entitled  "An  Act  to  de- 
fine and  fix  the  standard  of  value,  to  maintain  the  parity  of  all 
forms  of  money  issued  or  coined  by  the  United  States,  to  re- 

*  Cf.  the  author's  analysis  in  Money  and  Prices  (1919),  chap.  X. 


238  BANKING  PROGRESS 

fund  the  public  debt,  and  for  other  purposes,"  and  the  Secre- 
tary of  the  Treasury  may,  for  the  purpose  of  maintaining  such 
parity  and  to  strengthen  the  gold  reserve,  borrow  gold  on  the 
security  of  United  States  bonds  authorized  by  section  two  of 
the  Act  last  referred  to  or  for  one-year  gold  notes  bearing  in- 
terest at  a  rate  of  not  to  exceed  three  per  centum  per  annum, 
or  sell  the  same  if  necessary  to  obtain  gold. 

Thus  it  was  the  act  of  1913  rather  than  the  act  of 
1900  that  practically  established  the  gold  standard.^ 

Likewise,  the  only  provision  affecting  the  greenbacks 
is  that  (Sec.  7)  which  devotes  the  net  earnings  from 
Reserve  Banks  accruing  to  the  United  States  "to  supple- 
ment the  gold  reserve  held  against  outstanding  United 
States  notes,"  or  to  reduce  the  bonded  indebtedness,  at 
the  discretion  of  the  secretary  of  the  treasury.^ 

The  direct  purpose  of  the  new  act  is  to  replace  the 
national  bank  notes,  within  a  period  of  twenty  years  or 
more,  by  Federal  Reserve  notes.  These  notes  are  de- 
scribed as  follows  (Sec.  16) : 

Federal  reserve  notes,  to  be  issued  at  the  discretion  of  the 
Federal  Reserve  Board /or  the  purpose  of  making  advances  to  the 
Federal  reserve  banks  through  the  Federal  reserve  agents  as 
hereinafter  set  forth  and  for  no  other  purpose,  are  hereby  au- 
thorized. The  said  notes  shall  be  obligations  of  ilw  United 
States  and  shall  be  receivable  by  aU  national  and  member  banks 
and  Federal  reserve  banks  and  for  all  taxes,  customs,  and  other 
public  dues.  They  shall  be  redeemed  in  gold  on  demand  at  the 
Treasury  Department  of  the  United  States,  in  the  City  of 
Washington,  District  of  Columbia,  or  La  gold  or  lawful  money 
at  any  Federal  reserve  bank. 

These  notes  can  be  obtained  only  by  a  Federal  Reserve 
Bank,  on  the  deposit  of  an  equal  amount  of  commercial 
paper  as  defined  by  Sec.  13.     Each  note  issued  shall  carry 

>  C/.  swpra,  pp.  3,  11.  *  Amended  March  2,  1919. 


THE  FEDERAL  RESERVE  ACT  239 

on  its  face  the  distinctive  letter  and  serial  number  of  the 
Reserve  Bank  putting  it  out,  thus  making  each  Reserve 
Bank  responsible  for  the  redemption  of  its  own  issues. 
That  is,  instead  of  United  States  bonds,  as  in  the  case  of 
national  bank  notes,  the  ultimate  security  behind  the 
Federal  Reserve  notes  is  to  be  commercial  paper;  in  ad- 
dition these  notes  are  also  "a  first  and  paramount  lien 
on  all  the  assets"  of  the  issuing  Reserve  Bank.  The 
Federal  Reserve  Board,  through  its  federal  reserve  agent 
in  each  Reserve  Bank,  may  charge  the  latter  a  rate  of 
interest  on  these  notes,  at  its  option;  and  the  board  has 
the  right,  if  it  so  chooses,  to  refuse  entirely  any  applica- 
tion for  notes.  The  comptroller  of  the  currency  shall 
provide  the  plates  and  dies,  have  a  supply  of  notes  ready 
for  each  bank,  and  charge  all  expenses  to  such  banks. 
There  is  no  limit  to  the  total  amount  of  such  notes;  and 
there  is  no  tax  when  issues  pass  beyond  a  certain  sum, 
except  the  possible  charge  of  a  rate  of  interest,  as  just 
mentioned.  In  effect,  the  supply  of  these  notes  is  di- 
rectly related  to  the  supply  of  rediscounted  commercial 
paper,  although  the  whole  of  any  rediscount  is  not,  by 
any  means,  likely  to  be  paid  out  in  notes.  So  much  for 
the  methods  of  issuing  these  notes. 

As  regards  the  contraction  of  the  notes  when  not 
needed,  redemption  is  provided  for  by  gold  reserves  of 
40  per  cent  against  notes  outstanding.  No  Reserve 
Bank  shall  pay  out  the  notes  of  any  other  Reserve  Bank 
under  a  penal tj^  of  10  per  cent;  but  it  is  obliged  to  pre- 
sent such  notes  for  credit  or  redemption  to  the  bank  that 
issued  them.  Likewise,  Federal  Reserve  notes  presented 
at  the  Treasury  are  redeemed  out  of  a  gold  fund  left  with 
the  Treasury  by  the  Reserve  Banks  which  shall  not  be 
less  than  5  per  cent  (but  counting  as  part  of  the  40  per 
cent  reserve) ;  and  the  Treasury  will  remit  any  notes  thus 


240  BANKING  PROGRESS 

redeemed  to  the  respective  Reserve  Bank  for  reimburse- 
ment. A  Reserve  Bank,  although  required  to  hold  re- 
serves of  40  per  cent  in  gold  against  its  outstanding  notes, 
may  redeem  them  either  in  gold  or  lawful  money.  WTien 
a  Reserve  Bank  wishes  to  reduce  its  liability  for  Federal 
Reserve  notes,  even  if  its  own  notes  are  not  obtainable, 
it  may  deposit  with  the  federal  reserve  agent  any  Federal 
Reserve  notes,  gold,  gold  certificates,  or  lawful  money. 
By  these  provisions,  it  is  obvious  that  contraction  of 
notes,  not  needed  by  the  public,  is  fully  provided  for. 
In  short,  elasticity  of  note-issues — expansion  in  time  of 
need  and  contraction  when  the  need  has  passed — is  fully 
provided.  Furthermore,  there  can  be  no  possible  ques- 
tion as  to  their  safety,  secured  as  they  are,  first,  by  a  gold 
reserve  of  40  per  cent;  second,  by  the  pledge  of  picked 
commercial  paper  to  the  par  value  of  the  notes;  third, 
by  a  first  lien  on  all  the  assets  of  the  Reserve  Bank; 
and,  finally,  by  the  guaranty  of  the  United  States — an 
obligation  not  likely  ever  to  be  called  upon,  in  view  of 
the  prior  protection. 

The  language  of  the  act  (in  Sec.  16)  relating  to  Federal 
Reserve  notes  is  equivocal.  It  is  an  obvious  attempt  to 
satisfy  those  who  believe  in  government  issues  of  paper 
money;  while  at  the  same  time  it  is  not  the  purpose 
seriously  to  impair  the  real  functions  of  the  issues  as 
bank-notes.  Thus  the  final  outcome  of  the  time-honored 
dispute,  so  far  as  reached  by  this  act,  seems  to  be  in 
essence  and  in  practical  operation  a  settlement  in  favor  of 
bank-notes;  for  the  Federal  Reserve  notes  are  in  no  real 
sense  government  issues.  The  Treasury  has  no  power  to 
issue  them  in  payment  of  governmental  expenses;  since 
the  initiative  must  come  from  the  Reserve  Banks,  and 
only  on  the  offer  of  commercial  paper  originating  in  a 
private  business   transaction.     Although   not   so  stated 


THE   FEDERAL  RESERVE  ACT  241 

literally,  the  notes  are  liabilities  of  the  Reserve  Banks, 
since  they  must  redeem  them,  and  since  the  notes  are  a 
first  lien  on  all  the  assets  of  such  banks.  To  state  that 
the  notes  are  the  obligations  of  the  United  States  and 
may  be  redeemed  at  the  Treasury  is  only  "a  frill,"  of  no 
practical  import;  since  it  is  unlikel}^  that  the  government 
would  ever  be  called  upon  to  meet  this  obligation.  To 
say  that,  in  issuing  the  notes,  the  Treasury  is  "making 
advances"  to  the  Federal  Reserve  Banks  is  meaningless 
(and,  if  it  serves  a  political  purpose,  no  harm  is  done); 
since  the  action  of  the  board  in  passing  out  notes  in  re- 
turn for  a  pledge  of  commercial  paper  is  as  purely  admin- 
istrative as  the  present  action  of  the  comptroller  in 
handing  over  printed  national  bank  notes  in  return  for 
a  pledge  of  United  States  bonds.  Nothing  in  the  words 
of  the  act  can  be  construed  as  making  these  notes  gov- 
ernment issues,  any  more  than  national  bank  notes  are 
government  issues.^  On  this  outcome,  and  on  the  escape 
from  serious  monetary  error,  the  country  is  to  be  con- 
gratulated. 

The  law  looks  forward  to  a  new  basis  for  the  bank- 
note circulation  which  has  been  formerly  based  on  United 
States  bonds.  These  notes  are  eventually  to  be  dis- 
placed with  Federal  Reserve  notes  based  on  commercial 
paper.  This  displacement,  involving  the  disposal  of 
$740,000,000  of  United  States  bonds  now  used  to  secure 
circulation,  will  be  treated  later. 

A  national  bank  entering  the  new  system  is  not,  how- 
ever, obliged  to  give  up  its  present  circulation;  and  the 
withdrawal  of  national  bank  notes  by  existing  national 
banks  is  tied  up  with  the  disposal  of  the  bonds  to  which 

'  It  is  not  worth  while  to  give  attention  to  the  claim  that  Federal  Reserve 
notes  are  "fiat  money,"  on  the  ground  that,  being  government  obligations, 
the  government  makes  no  provision  for  their  redemption.  Other  provisions 
remove  them  from  this  imputation. 


242  BANKING  PROGRESS 

the  circulation  privilege  is  already  attached.  Nor  are 
national  banks  obliged  to  present  their  bonds  for  ex- 
change into  others  having  no  circulation  privilege  under 
Sec.  18,  unless  they  choose.  Consequently,  the  displace- 
ment of  existing  national  bank  notes  by  Federal  Reserve 
notes  will  be  long  deferred.  If  it  were  possible  to  dispose 
of  the  bonds  amounting  to  $740,000,000  to  the  full  satis- 
faction of  the  banks,  how  could  an  equal  amount  of 
Federal  Reserve  notes  be  issued  to  take  their  place  .'*  Since 
the  latter  were  to  be  secured  only  by  commercial  paper, 
instead  of  bonds,  it  follows  that  there  would  have  been 
a  considerable  contraction  of  bank-notes,  unless  the 
Reserve  Banks  had  prime  discounted  paper  on  hand  to 
at  least  $740,000,000.  Obviously,  this  sum  could  not  be 
counted  on;  and  a  contraction  of  the  currency  would  not 
have  been  politically  wise.  Hence  the  provisions  of  the 
House  bill,  allowing  a  more  or  less  rapid  substitution  of 
Reserve  notes  for  national  bank  notes,  were  dropped  by 
the  Senate.  Of  course,  under  the  new  act,  quite  inde- 
pendently of  the  national  bank  circulation  secured  by 
bonds.  Federal  Reserve  notes  may  be  issued  at  any  time 
to  any  amount  according  to  the  provisions  of  Sec.  16. 
If  issued,  they  would  be  an  addition  to  the  existing  national 
bank  circulation;  and  the  security  behind  them  would 
be  commercial  paper,  not  bonds. ^ 

If,  however,  national  banks  prefer  to  sell  their  bonds 
they  may  do  so,  after  December  23,  1915,  and  within  a 
period  of  twenty  years  thereafter,  in  limited  amounts 
each  year  (Sec.  18).  The  bonds  thus  disposed  of  by  the 
banks  are  to  be  taken  over  by  the  Federal  Reserve  Banks; 
and  the  latter  are  then  to  be  allowed  to  take  out  national 
bank  notes  on  depositing  these  bonds  with  the  comp- 
troller, in  the  same  way  as  national  banks  did;  although 

1  Set  act  of  June  il.  1917,  and  Chapter  XI,  §  8. 


THE  FEDERAL  RESERVE  ACT  243 

they  are  not  obliged  to  do  so.^  To  the  extent  that  Fed- 
eral Reserve  Banks  should  not  take  out  notes  on  the 
bonds  they  have  acquired  there  would  be  a  contraction 
of  the  national  bank  circulation.  But  it  is  planned  to 
prevent  any  considerable  contraction  of  the  national 
bank  circulation,  even  if  the  national  banks  dispose  of 
their  bonds  {cf.  Sec.  4,  Eighth).  The  final  disposal  of 
these  bonds  by  the  Federal  Reserve  Banks  will  be  dis- 
cussed later. 

Understanding  that  the  national  bank  circulation  is 
not  likely  to  be  much  reduced  for  the  present,  while  the 
Reserve  Ba!:ks  may  at  any  time  add  to  the  existing  mon- 
etary supply,  are  we  to  expect,  so  far  as  notes  are  con- 
cerned, an  undesirable  expansion.''  By  expansion  must 
be  meant  the  tendency  to  grant  loans,  through  the  too 
great  ease  of  issuing  notes  or  granting  credits,  without 
due  regard  to  the  soundness  of  the  transaction  giving 
rise  to  commercial  assets.  So  long  as  loans  are  carefully 
restricted  to  safe  loans  based  on  an  actual  exchange  of 
goods  no  swelling  of  liabilities  occurs  which  must  be 
finally  reduced  by  forced  liquidation.  That  is,  undue 
expansion  has  its  origin  in  excessive,  or  unsound,  loans. 
An  extension  of  bank-notes,  then,  can  cause  expansion 
only  so  far  as  it  aids  in  an  expansion  of  loans.  If  so, 
how  will  the  note-issues  under  the  new  act  work.^* 

An  increase  in  bank-notes  can  be  used  for  two  general 
purposes:  (1)  to  satisfy  the  need  of  a  medium  of  exchange 
in  the  hands  of  the  public;  or,  (2)  to  supply  bank  reserves. 
In  the  former  case,  if  pocket-money  and  till-money  is 
already  sufficiently  supplied,  then,  unless  the  monetary 

1  If  these  notes  are  issued  to  Federal  Reserve  Banks  under  the  same  condi- 
tions as  to  national  banks,  the  former  must  pay  the  tax  of  3^  of  1  per  cent,  if 
the  bonds  pay  only  2  per  cent;  but  in  Sec.  7  the  former  are  free  from  federal 
taxation.  Cf.  Conway  and  Patterson,  The  Operation  of  the  New  Bank  Act, 
pp.  138-139. 


244  BANKING  PROGRESS 

customs  of  the  people  have  changed,  no  more  bank-notes 
will  remain  in  circulation,  provided  they  are  redeemable 
in  gold  or  lawful  money.  In  the  latter  case,  the  Federal 
Reserve  notes  cannot  be  kept  as  reserves  by  member 
banks.  But,  it  is  said,  they  may  be  presented,  the  same 
day  they  are  obtained  on  a  loan,  for  gold  and  lawful  money 
by  which  reserves  could  be  enlarged.  On  the  contrary, 
if  a  member  bank  wished  to  increase  its  reserves  by  a 
rediscount,  it  would  not  need  to  draw  notes  at  all,  but 
would  leave  the  proceeds  of  the  loan  to  its  credit  at  the 
Reserve  Bank,  in  which  form  it  is  ipso  facto  added  to  its 
reserve  account.  There  still  remains,  however,  the  pos- 
sibility of  getting  Federal  Reserve  notes  and  exchanging 
them  for  la^dPul  money  at  a  non-member  bank  which 
can  use  Federal  Reserve  notes  as  reserves.^  There  would, 
however,  be  no  more  reason  for  this  action  than  for  the 
one  just  mentioned,  since  it  would  be  less  trouble  to 
leave  the  proceeds  of  a  loan  at  a  Federal  Reserve  Bank 
on  deposit  where  it  would  count  as  reserve.  For  these 
general  reasons,  then,  there  does  not  seem  to  be  any 
ground  for  apprehension  that  the  Federal  Reserve  notes 
will,  if  based  only  on  commercial  paper,  be  so  put  into 
circulation  as  to  cause  expansion.  If  any  such  expan- 
sion is  intended,  it  can  be  more  easily  accomplished, 
without  the  use  of  the  notes,  through  loans,  deposit- 
accounts,  and  checks. 

There  are  those,  however,  who  measure  expansion  by 
the  increase  of  prices.  They  probably  hold  that  an  ad- 
dition to  the  circulation,  according  to  the  quantity- 
theory  of  prices,  would  raise  prices;  also,  that  an  exten- 
sion of  loans,  without  the  use  of  bank-notes,  would  stim- 
ulate credit  and  raise  prices.-    Redemption,  on  the  other 

*  Cf.  Conway  and  Patterson,  op.  cii.,  p.  152. 

*  Cf.  O.  M.  W.  Sprague,  "The  Federal  Reserve  Act  of  1913,"  Quarterly  Jouraal 
of  Economics,  February,  1914,  p.  240. 


THE  FEDERAL  RESERVE  ACT  245 

hand,  would  always  force  a  test  of  the  solvency  of  the 
transaction  on  which  the  credit  is  based;  thus  credit  is 
kept  wholesome  and  normal,  so  long  as  unsound  loans 
are  prevented.^  A  possibility  of  undue  inflation  is  sug- 
gested, it  may  be  mentioned,  by  such  a  reduction  of  re- 
serve requirements  as  would  weaken  the  certainty  of 
redemption;  but  this  consideration  could  not  apply  to 
the  Federal  Reserve  notes,  under  this  act. 

§  5.  The  removal  of  a  bank  circulation  secured  by 
United  States  bonds  having  been  determined  upon  by 
general  consent,  a  practicable  and  just  disposal  of  the 
$740,000,000  bonds  has  not  been  easily  found.  The 
largest  part  of  these  bonds  yield  only  2  per  cent;  solely 
as  an  investment  they  would  sell  below  70;  but,  since 
they  have  the  "circulation  privilege"  (or  right  to  serve 
as  security  for  national  bank  notes),  the  demand  for  them 
by  national  banks  in  the  past  has  kept  them  above  par, 
some  having  sold  even  as  high  as  110.  When  the  new 
bill  appeared,  the  national  banks  were  directly  con- 
cerned with  the  possibility  of  losses  on  their  bonds,  if 
the  circulation  privilege  were  withdrawn  from  them.  In 
the  proposed  law  the  treatment  of  these  bonds  was  the 
problem  least  well  thought  out. 

When  the  Glass  Bill  became  known,  June  18,  1913,  it 
contained  sections  then  numbered  18,  19,  and  20.  Sec. 
18  provided  that  no  national  bank  should  issue  notes  in 
excess  of  the  amount  outstanding  at  the  passage  of  the 
act;  Sec.  19  repealed  the  former  acts  requiring  banks  to 
hold  bonds  to  the  amount  of  one-fourth  of  their  capital 
(if  less  than  $150,000) ;  and  Sec.  20  required  the  secretary 

^  "The  security  against  the  consequences  of  inflation  is  not  to  be  found  in 
the  limitation  or  extinction  of  notes,  but  in  specie  redemption  for  all  liabilities, 
and  in  the  encouragement  given  sound  banking  by  steady  oversight  and  pub- 
licity" (C.  F.  Dunbar,  Economic  Essays,  p.  185). 


246  BANKING  PROGRESS 

on  application  to  exchange  the  2  per  cent  bonds  having 
the  circulation  privilege  for  3  per  cents  not  having  this 
privilege  (but  payable  twenty  years  from  date  and  ex- 
empt from  all  taxation)  to  an  amount  each  year  not  ex- 
ceeding 5  per  cent  of  the  total  quantity  of  bonds  held 
by  the  Treasury,  while,  as  fast  as  the  2s  were  refunded, 
*'the  power  of  national  banks  to  issue  circulating  notes 
secured  by  United  States  bonds  shall  cease  and  termi- 
nate"; and  at  the  end  of  twenty  years  all  the  2s  should  be 
exchanged  for  3s,  and  all  national  bank  notes  should  be 
recalled  and  redeemed. 

To  most  politicians  the  note  question  is  of  primary 
importance;  indeed,  to  allow  banks  under  any  circum- 
stances to  issue  notes  is  to  grant  the  "money -power"  a 
privilege.  Conferences  of  leaders  were  held.  Senator 
Owen,  chairman  of  the  Senate  committee,  demanded 
the  omission  of  Sees.  18,  19,  and  20  in  order  that  the 
question  might  be  left  to  future  legislation;  and  he  gained 
his  point.  Then,  on  the  representation  of  a  committee 
of  the  American  Bankers'  Association,  these  sections  of 
the  bill  were  reinserted;  and  on  June  26,  1913,  the  bill 
including  them  was  introduced  into  the  House  and 
Senate. 

As  these  sections  stood,  the  2s  could  not  be  sold  in 
the  future  to  secure  circulation,  since  no  more  national 
bank  notes  could  be  issued  than  were  outstanding  at  the 
passage  of  the  act;  and  the  only  outlet  would  be  their 
exchange  for  3s.  On  June  28  the  financial  columns  of 
the  press  noted  a  decline  in  the  price  of  the  2s  to  par. 
At  the  best  they  could  not  sell  higher  than  the  3s  into 
which  they  were  to  be  exchanged;  and  European  states 
were  not  able  to  borrow  at  par  at  3  per  cent.  Just  at 
that  time  a  tendency  of  the  interest  rate  on  permanent 
investments   toward   a   higher   level   showed   itself.    It 


THE  FEDERAL  RESERVE  ACT  247 

might  be  that  within  the  term  of  twenty  years  the  3s 
might  not  be  worth  par,  it  was  said;  thus,  somehow, 
the  belief  spread  that  on  the  passage  of  the  act  the  cir- 
culation privilege  would  be  practically  taken  away. 
But,  whatever  the  reason,  timid  holders  of  the  2s  began 
to  throw  them  on  the  market;  hence,  as  the  demand 
was  small,  a  very  few  offers  were  sufficient  to  send  down 
the  price,  and  during  Julj^  they  were  quoted  at  95. 

United  States  bonds  (including  2s)  had  also  been  used 
to  secure  government  deposits  with  the  banks  (some  $50,- 
000,000).  If  by  the  new  act  government  deposits  were 
to  be  transferred  to  the  Federal  Reserve  Banks,  then  the 
demand  for  2s  (or  any  other  United  States  bonds)  as  a 
security  for  deposits  would  to  that  extent  be  diminished. 

This  embarrassing  situation^  brought  out  a  statement 
from  Washington  about  the  middle  of  July  that  Sec.  20 
would  be  so  modified  as  to  allow  all  banks  to  take  out 
circulation  on  the  2s  as  long  as  they  were  not  exchanged 
for  3s;  that  the  exchange  of  2s  into  3s  would  be  per- 
missive; and  that  at  the  end  of  twenty  years  the  holder 
of  2s  would  receive  par  and  accrued  interest  in  cash. 
In  effect,  the  circulation  privilege  was  to  be  restored. 
It  was  also  stated  that  Sec.  18  had  been  left  in  the  bill 
by  error;  and  when  the  bill  was  presented  to  the  House 
caucus  August  15,  Sec  18  had  been  omitted.     More- 

'  As  a  consequence  of  the  fall  in  the  prices  of  the  2s,  Secretary  McAdoo  on 
July  28,  1913,  made  the  following  statement  to  the  public: 

"The  2  per  cent  bonds  are  worth  par,  notwithstanding  their  decline  in  the 
New  York  market,  a  decline  due  not  to  any  impairment  of  their  intrinsic  value, 
but  .^almost  wholly  to  what  appears  to  be  a  campaign  waged  with  every  indica- 
tion of  concerted  action  on  the  part  of  a  number  of  influential  New  York  city 
banks  to  cause  apprehension  and  uneasiness  about  these  bonds,  in  order  to 
help  them  in  their  efforts  to  defeat  the  currency  bill." 

The  banks  retorted  that  it  was  unlikely  they  would  try  to  impair  the  value 
of  their  own  assets  amounting  to  $740,000,000.  On  the  other  hand,  the  state- 
ment might  have  retained  radical  support  in  Congress  for  a  bill  supposed  to 
be  antagonized  by  the  large  banks. 


248  BANKING  PROGRESS 

over,  at  this  time  (July  31)  Secretary  McAdoo  announced 
he  would  deposit  $25,000,000  to  $50,000,000  of  govern- 
ment funds  with  the  banks  of  the  South  and  West  to 
reheve  any  autumnal  stringency.  To  get  these  deposits 
banks  must  have  outstanding  at  least  40  per  cent  of  their 
authorized  circulation,  and  if  they  pledged  government 
bonds  these  would  count  as  par  against  deposits.  To  that 
extent  the  demand  for  United  States  bonds  would  be  in- 
creased and  their  price  be  raised.^ 

Finally,  in  the  later  stages  of  this  legislation,  the  present 
provisions  regarding  bonds  were  inserted  in  Sec.  18  of 
the  new  act.  After  December  23,  1915,  and  for  twenty 
years  thereafter,  any  member  bank  wishing  to  retire  its 
circulation  may  offer  its  bonds  at  par  to  the  Treasury  of 
the  United  States;  at  the  end  of  each  quarter,  the  Fed- 
eral Reserve  Board  may  require  each  Federal  Reserve 
Bank  to  purchase  a  certain  proportion  of  the  bonds  of- 
fered. The  Reserve  Banks  may  then  take  out  notes, 
under  the  same  conditions  as  national  bank  notes,  equal 
in  amount  to  the  bonds  they  have  purchased.  If  they 
do  this,  there  will  be  no  contraction  of  notes  secured  by 
bonds. 

It  is  expected,  however,  that  Federal  Reserve  Banks 
will  not  present  to  the  comptroller  all  their  bonds  as  se- 
curity for  notes;  since  any  Reserve  Bank  may  have  its 
2  per  cent  bonds  against  which  no  circulation  is  out- 
standing refunded,  one-half  into  thirty-year  3  per  cent 
gold  bonds  without  the  circulation  privilege,  and  one- 
half  into  one-year  gold  notes  of  the  United  States  bearing 

^  Furthermore,  State  and  municipal  bonds,  etc.,  other  than  bonds  of  the 
United  States,  would  be  accepted  at  a  valuation  of  only  75  per  cent,  and  prime 
commercial  paper  at  65  per  cent.  This  was  the  first  time  commercial  assets 
were  ever  permitted  under  the  act  of  March  4,  1907  (Sec.  3)  to  be  used  as 
security  for  government  deposits.  Since  the  passage  of  the  present  act,  it  has 
no  further  importance,  except  that  it  went  far  beyond  the  action  of  Secretary 
Shaw,  so  much  criticised  in  his  time. 


THE  FEDERAL  RESERVE  ACT  249 

S  per  cent  interest,  without  the  circulation  privilege. 
Thus,  instead  of  the  2s,  it  may  have  long-term  3  per 
cent  bonds  which  it  can  sell  in  the  open  market,  and  one- 
year  notes  which  will  be  highly  useful  in  borrowing  gold 
in  any  foreign  market.  To  the  extent  that  Federal  Re- 
serve Banks  refund  their  bonds  the  national  bank  cir- 
culation will  be  reduced;  but  at  no  time  will  the  bonds 
held  by  member  banks  lose  their  circulation  privilege, 
and  after  two  years  from  the  passage  of  the  act  they  can 
be  sold  at  par  in  amounts  of  not  more  than  $25,000,000 
in  any  one  year.  It  follows,  therefore,  that  not  all  the 
bonds  can  be  disposed  of  in  twenty  years. 

§  6.  The  lending  power  of  a  bank,  whether  the  loan 
is  carried  through  by  notes  or  by  a  deposit-account  given 
to  the  borrower,  is  influenced  by  the  regulations  affect- 
ing reserves,  which  are  the  cash  means  for  meeting  de- 
mand-liabilities. On  this  important  feature,  it  should 
be  noted  that  the  plan  of  the  National  Monetary  Com- 
mission made  no  changes  in  the  old  system  of  reserves. 
Under  the  old  national  banking  system,  country  banks 
were  obliged  to  hold  15  per  cent  reserves  in  lawful  money 
against  deposits,  of  which  9  per  cent  could  be  kept  with 
banks  in  reserve  or  central  reserve  cities;  the  banks  in 
the  forty-seven  reserve  cities  were  obliged  to  hold  re- 
serves of  25  per  cent,  of  which  123/^  per  cent  could  be 
kept  with  banks  in  central  reserve  cities;  while  banks  in 
the  three  central  reserve  cities  had  to  maintain  reserves 
of  25  per  cent.  Moreover,  the  required  redemption  fund 
of  5  per  cent  of  outstanding  circulation  could  be  counted 
toward  reserves  for  deposits.  This  redepositing  of  re- 
serves in  trade  centres  arose  for  business  reasons:  cus- 
tomers of  local  banks  needed  drafts,  or  exchange,  on 
cities  where  they  purchased  goods;   and  such  banks  had 


250  BANKING  PROGRESS 

to  keep  funds  there  on  which  to  draw.  That  is,  rede- 
positing  of  reserves  was  due  to  the  need  of  exchange. 
Whether  there  were  reserve  laws  or  not,  funds  would 
have  converged  where  the  most  goods  were  bought  and 
sold.  Some  centralization  of  cash  in  this  way  was  normal 
and  inevitable. 

By  selling  exchange  on  large  city  banks  a  local  bank 
creates  demand-liabilities  at  a  distance;  yet  it  has  de- 
mand-liabilities in  its  deposit-accounts  at  home.  The 
two  things  are  different  and  lead  to  much  confusion  of 
mind.  The  sum  kept  with  a  city  correspondent  to  cover 
exchange  is  really  only  a  checking  account,  and  in  no 
sense  a  real  reserve  in  cash  that  can  be  called  for  on  de- 
mand; it  is  constantly  being  wiped  out  and  replenished 
by  miscellaneous  items.  But  under  the  delusion  that 
these  funds  are  reserves  (strengthened  by  the  fact  that 
the  law  permits  them  to  be  called  legal  reserves),  local 
banks  seem  to  think  they  can  call  on  them  in  time  of 
stress;  then,  of  course,  they  cannot  get  the  cash,  and  are 
highly  indignant.  In  truth,  checking  accounts  to  cover 
exchange  are  not  real  banking  reserves.  This  considera- 
tion should  be  kept  in  mind  in  studying  the  effect  of  the 
reduction  of  the  percentage  for  reserves  in  the  new  act. 

For  demand-deposits,  in  the  new  law,  a  country  bank 
was  required  to  maintain  reserves  of  12  per  cent;  three 
years  after  the  establishment  of  the  Federal  Reserve 
Banks,  4  per  cent  must  be  kept  at  home,  5  per  cent  in 
the  Federal  Reserve  Bank,  and  the  remaining  3  per  cent, 
either  at  home  or  with  the  Reserve  Bank  at  the  option  of 
the  country  bank.^  That  is,  after  three  years,  no  funds 
left  with  city  correspondents  could  be  counted  as  legal 

*  In  the  transition  period  of  three  years  the  country  bank  must  keep  5  per 
cent  at  home;  in  the  Federal  Reserve  Bank  for  the  first  twelve  months  2  per 
cent;  and  for  each  succeeding  six  months  an  additional  1  per  cent,  until  5  per 
cent  was  reached. 


THE  FEDERAL  RESERVE  ACT  251 

reserves.  In  short,  funds  to  cover  exchange,  so  long  as 
it  was  drawn  on  city  correspondents,  must  be  carried 
independently  of  legal  reserves.  On  the  other  hand,  if 
exchange  is  drawn  in  the  future  on  the  Federal  Reserve 
Banks,  or  branches  (instead  of  on  other  banks),  funds 
counted  as  reserves  will  still  be  used  to  cover  exchange. 
Therefore,  the  reduction  in  the  minimum  requirement 
from  15  to  12  per  cent  reserve  is  more  nominal  than  real. 

A  reserve  city  bank,  in  the  new  act,  is  required  to 
maintain  reserves  of  15  per  cent  of  its  demand-deposits; 
after  three  years,  5  per  cent  shall  be  kept  at  home,  6 
per  cent  in  its  Federal  Reserve  Bank,  and  the  remaining 
4  per  cent  either  at  home  or  with  the  Reserve  Bank  at 
option.^  As  with  country  banks,  no  deposits  in  other 
banks  will  then  count  as  legal  reserves. 

A  central  reserve  city  bank  was  required  to  hold  re- 
serves of  18  per  cent  against  its  demand-deposits,  of  which, 
from  the  beginning,  6  per  cent  must  be  kept  in  its  own 
vaults,  7  per  cent  in  its  Federal  Reserve  Bank,  and  the 
remaining  5  per  cent  either  at  home  or  with  its  Reserve 
Bank  at  its  option. 

Inasmuch  as  items  passing  from  a  depositing  bank  to 
its  reserve  agent  should  not  be  counted  as  reserves  until 
collected,  they  should  not  be  included  by  the  reserve 
agent  as  deposits  on  which  reserves  are  to  be  computed. 
The  new  act,  therefore,  enacted  (Sec.  20)  that  "in  esti- 
mating the  reserves  required  by  this  Act,  the  net  balance 
of  amounts  due  to  and  from  other  banks  shall  be  taken 
as  the  basis  for  ascertaining  the  deposits  against  which 
reserves  shall  be  determined.     Balances  in  Reserve  Banks 

^  In  the  transition  period  of  three  years  such  a  bank  must  keep  6  per  cent  at 
home;  in  the  Federal  Reserve  Bank  for  the  first  twelve  months  3  per  cent; 
and  for  each  succeeding  six  months  an  additional  1  per  cent,  until  6  per  cent 
was  reached.  For  changes  before  the  transition  period  expired,  in  all  three 
classes,  see  Chapter  XI,  §  2. 


252 


BANKING  PROGRESS 


due  to  member  banks  shall,  to  the  extent  herein  provided, 
be  counted  as  reserves." 

For  all  these  classes  of  banks  a  new  distinction  is  in- 
troduced between  demand  and  time  deposits:  demand- 
deposits  comprise  all  those  payable  within  thirty  days, 
and  time-deposits  all  those  payable  after  thirty  days, 
including  savings-accounts,  etc.,  subject  to  thirty  days' 
notice.  Any  bank  is  required,  in  addition  to  the  above 
requirements  for  demand-deposits,  to  hold  only  5  per 
cent  reserves  against  time-deposits.  As  nearly  as  can 
be  estimated,  about  one-third  of  the  deposits  of  country 
banks  are  time-deposits;  of  reserve  city  banks,  about 
8  per  cent;  of  central  reserve  city  banks,  about  1  per 
cent.  Taking  into  account  both  the  reduction  of  re- 
serves against  demand-deposits,  and  that  due  to  the 
low  rate  on  time-deposits,  the  nominal  reserves  (irrespec- 
tive of  redepositing)  have  been  lowered  in  the  new  law 
by  more  than  one-third,  as  may  be  seen  from  Table  I, 
based  on  the  reports  of  the  condition  of  national  banks, 
March  4,  1914; 

TABLE  I 

[In  millions] 


March  4,  1914 

Net 
deposits 

Total 
time- 
certifi- 
cates 

Total 
savings- 
deposits 

Total 

time; 

deposits 

Required 
reserves 

under  old 
system 

Required 
reserves 

under  new 
system 

Reserves 

released 

under 

new  act 

Country  banks 
Reserve     city 

banks 

Central   reserve 
city  banks  . . . 

$3,761 
1,970 
1,773 

$485 
59 
15 

$777 
93 

1 

$1,262 

152 

16 

$564 
492 
443 

$363 
280 
317 

$201 
212 
126 

Totals 

$7,504 

$559 

$871 

$1,430 

$1,499 

$960 

$593 

Although  the  nominal  reserves,  especially  of  country 
banks,  have  thus  been  lowered,  there  remains  the  problem 
of  the  effect  on  the  banks  and  on  business  of  the  transfer 


THE  FEDERAL  RESERVE  ACT 


^53 


of  reserves,  if  any,  from  the  reserve  city  banks  to  the 
Federal  Reserve  Banks.  As  to  the  sums  which  must 
be  at  once  moved  to  comply  with  the  law,  the  com- 
putations^ which  have  been  made  show  clearly  that  the 
cash  holdings  of  the  various  classes  of  banks  are  more 
than  suflScient  to  cover  the  transfers  of  the  reserves,  the 
payment  of  the  required  3  per  cent  on  the  capital  sub- 
scription of  6  per  cent  upon  capital  and  surplus,  and  to 
retain  enough  reserves  in  their  own  vaults  to  meet  the 
requirements  of  the  act.  That  is,  it  would  not  be  neces- 
sary for  banks  to  call  upon  their  reserve  agents  to  cover 
the  initial  payments  to  the  Federal  Reserve  Banks;  but 
it  is  assumed  that  one-half  of  the  reserves  to  be  first 
paid  into  the  Federal  Reserve  Banks  could  be  obtained 
(as  permitted  in  Sec.  20)  by  deposit  of  eligible  commercial 
paper  (as  described  in  Sec.  13).  In  short,  these  figures 
present  the  minimum  transfers  in  initiating  the  new 
system. 

In  viewing  the  effect  of  the  transfer  of  funds  on  busi- 
ness loans,  it  is  to  be  noted  that,  of  course,  the  whole  of 
the  amount  deposited  by  local  banks  in  reserve  city  banks 
is  not  needed  merely  to  cover  exchange.  As  is  well 
known,  the  payment  of  2  per  cent  interest  on  deposits 

1  C/.  W.  A.  Scott,  "Banking  Reserves  Under  the  Federal  Reserve  Act," 
Journal  of  Political  Economy,  April,  1914. 

[In  millions] 


January  13,  1914 

Country  banks 

Reserve  city 
banks 

Central  reserve 
city  banks 

Total  cash  holdings 

$284.0 

37.4 

29.8 

186.9 

29.7 

$286.6 

28.6 

13.4 

114.4 

112.2 

$429.2 

55.3 

10.4 

94.8 

268.5 

One-half  deposit  of  reserves 

3  per  cent  subscription  to  capital. . 

Reserves  required  at  home 

Balance  of  cash  holdings 

See  also  the  figures  of  Conway  and  Patterson,  op.  (it.,  pp.  251-252,  259, 
267-269,  272,  275-276,  299,  301,  306. 


^54 


BANKING  PROGRESS 


by  reserve  agents  attracts  funds  when  idle  at  home;  and 
a  large  deposit-account  with  its  city  correspondent  gives 
the  local  bank  corresponding  advantages  of  treatment. 
In  the  report  of  same  date  the  figures  were  as  given  in 
Table  II. 

TABLE  II 

[In  millions] 


March  4, 1914 

Cash  and  5  per  cent 
redemption  fund 

Deposits  with 
reserve  agents 

Country  banks 

$291 
261 
449 

$551 
286 

Reserve  city  banks 

Central  reserve  city  banks 

$1,001 

$837 

The  total  net  deposits  of  national  banks  subject  to 
reserve  requirements  at  that  date  were  $7,504,000,000. 
Thus  the  actual  cash  of  $1,001,000,000  was  only  13.3 
per  cent  of  deposits;  since  the  $837,000,000  of  deposits 
with  reserve  agents  was  not  cash.  Hence  the  demand 
of  member  banks  upon  their  reserves  in  the  reserve  cities, 
if  made,  for  transferrence  to  Federal  Reserve  Banks 
would  really  fall  upon  the  $1,001,000,000  of  cash  actually 
held  in  the  present  system. 

The  important  consideration,  however,  lies  in  the  effect 
on  the  lending  power  of  the  banks  after  and  because  of 
these  transfers.  With  the  balances  left  over  in  their 
reserves,  could  they  still  care  for  their  customers  ?  That 
question  is  obviously  the  one  which  forced  the  banks 
to  be  cautious  with  loans  until  the  adjustment  was  finally 
completed.  There  are,  however,  two  matters  which  might 
relieve  any  possible  tension.  In  the  first  place,  the  above 
computation  has  not  called  for  withdrawals  from  reserve 
city  banks.  It  is  well  to  be  on  the  safe  side  in  this 
matter;  for  the  reserves  with  reserve  city  banks  could  not 


THE  FEDERAL  RESERVE  ACT  255 

be  called  upon  to  any  extent  in  cash,  since  they  are 
themselves  the  basis  of  loans  made  by  the  city  banks. 
But,  in  the  second  place,  the  most  important  and  effec- 
tive method  of  taking  care  of  the  needs  of  customers  in 
the  transition  period,  and  the  one  which  would  keep 
credits  flexible,  would  be  the  rediscounting  of  short- 
time  paper  by  member  banks  at  the  Federal  Reserve 
Banks.  The  immediate  effect  of  such  a  rediscount 
would  be  an  increase  of  the  reserves  of  the  member  bank, 
so  long  as  the  proceeds  of  the  rediscount  were  left  with 
the  Federal  Reserve  Bank. 

In  addition,  the  use  of  government  deposits  in  this 
transitional  period  would  be  a  very  important  element. 
The  deposits  of  the  United  States  then  held  by  national 
banks  was  about  $58,000,000;  while  the  other  funds  of 
the  Treasury  would  allow  the  deposit  of  a  much  larger 
sum  with  the  banks.  Instead  of  placing  large  amounts 
with  Federal  Reserve  Banks  at  the  outset,  it  might  be 
wise  to  aid  the  member  banks  by  additional  deposits. 

As  a  counterweight  to  this  possible  restriction  on  loans, 
it  should  be  kept  in  mind  that  the  deposits  of  funds 
with  city  correspondents  to  cover  exchange  would  no 
longer  be  so  necessary,  if  instead  exchange  were  drawn  on 
the  Federal  Reserve  Banks  where  funds  existed  to  cover 
such  drafts.  To  be  sure,  the  payment  of  2  per  cent  in- 
terest on  deposits  with  the  city  banks,  and  the  tendency 
to  continue  long-established  relations  with  these  agents, 
would  work  to  retain  the  old  exchange  methods  and  to 
keep  funds  with  city  correspondents. 

The  general  effect  of  the  changes  in  the  reserve  system 
seem,  on  their  face,  to  make  easier  an  expansion  of 
credit.  That  is,  less  cash  reserves  need  to  be  carried; 
but  member  banks  would  have  no  reason  for  carrying 
as  high  reserves  as  in  the  past,  if  they  hold  short- time 


256  BANKING   PROGRESS 

paper  such  as  they  can  use  in  getting  discounts  from  the 
Federal  Reserve  Banks.  And  yet,  in  the  transitional 
period,  we  are  likely  to  see  more  or  less  caution  and  re- 
striction of  credit.  That  is,  at  the  start,  the  tendencies 
toward  expansion  and  restriction  very  nearly  balance 
each  other. 

As  concerns  the  reserves  of  the  Federal  Reserve  Banks, 
as  distinct  from  member  banks,  there  is  a  requirement 
of  a  35  per  cent  reserve  against  deposits  to  be  kept  in 
gold  or  lawful  money;  and  against  outstanding  Federal 
Reserve  notes  a  reserve  of  40  per  cent  in  gold.  Any  re- 
serve requirements  specified  in  this  act,  however,  may 
be  suspended  for  thirty  days  (and  later  for  fifteen  days 
at  a  time)  provided  a  graduated  tax  is  imposed  on  the 
deficiencies.     Further  it  is  enacted  (Sec.  11  (c)): 

That  when  the  gold  reserve  held  against  Federal  reserve 
notes  falls  below  forty  per  centum,  the  Federal  Reserve  Board 
shall  establish  a  graduated  tax  of  not  more  than  one  per  centum 
per  annum  upon  such  deficiency  until  the  reserve  falls  to  thirty- 
two  and  one-haK  per  centum,  and  when  said  reserve  falls  below 
thirty-two  and  one-half  per  centum,  a  tax  at  the  rate  increas- 
ingly of  not  less  than  one  and  one-half  per  centum  per  annum 
upon  each  two  and  one-half  per  centum  or  fraction  thereof 
that  such  reserve  falls  below  thirty-two  and  one-half  per  cen- 
tum. The  tax  shall  be  paid  by  the  reserve  bank,  but  the  re- 
serve bank  shall  add  an  amount  equal  to  said  tax  to  the  rates 
of  interest  and  discount  fixed  by  the  Federal  Reserve  Board. 

Under  the  provisions  of  the  act,  a  Federal  Reserve 
Bank  might  carry  no  gold  at  all  behind  its  deposits,  and 
only  the  40  per  cent  of  gold  behind  its  notes;  since  even 
then  it  could  redeem  its  notes  in  lawful  money.  Thus 
the  gold  reserve  beyond  the  40  per  cent  behind  notes  is, 
in  effect,  available  for  either  of  the  two  demand-liabili- 
ties, deposits  or  notes. 


THE  FEDERAL  RESERVE  ACT  257 

§  7.  The  Federal  Reserve  Act  of  1913  undoubtedly 
opens  for  this  country  an  entirely  new  epoch  in  the  opera- 
tions of  credit  and  currency.  Possibly  because  the  de- 
velopments in  credit  and  in  the  mechanism  of  exchange 
have  produced  momentous  changes  in  the  last  fifty  or 
seventy-five  years,  it  is  safe  to  say  that  an  act  which 
should  fully  meet  the  conditions  of  to-day  must  be  more 
important  than  any  previous  banking  statute,  not  ex- 
cepting the  National  Banking  Act  of  1864,  or  the  act 
of  1791  establishing  the  first  United  States  Bank.  Cer- 
tainly no  previous  measure  has  attempted  to  strike  di- 
rectly at  the  long-recognized  rigidity  of  our  credit  system, 
which  has  itself  led  to  unnecessary  paroxysms  of  trade 
in  the  past,  and  which  has  also  brought  to  light  the  under- 
lying weaknesses  of  our  currency  system.  For,  wider 
and  deeper  than  the  inelasticity  of  our  circulation  has 
been  the  inelasticity  of  our  credit  system.  And  yet, 
until  this  act,  practically  the  whole  attention  of  reform- 
ers had  been  directed  to  creating  an  elastic  note  system. 
In  the  work  of  the  Indianapolis  Monetary  Commission 
of  1898  this  was  eminently  true. 

So  far-reaching  a  measure  as  this  demands  comparison 
with  the  great  enactments  of  other  countries,  especially 
with  the  English  Bank  Act  of  1844.  That  law  was  passed 
to  meet  a  situation  not  unlike  our  own:  gold  redemp- 
tion had  been  secured  since  1821;  crises  had  been  dis- 
agreeably destructive;  it  was  desired  to  have  a  note- 
circulation  which  would  act  like  gold;  as  with  us  now, 
the  use  of  checks  drawn  upon  deposit-accounts  had  been 
growing;  but  it  was  generally  believed  that  all  difficul- 
ties were  traceable  to  the  note-issues.  Then  came  the 
act  of  1844,  which  set  the  notes  off  by  themselves  in  the 
issue  department;  while  the  deposit  and  discount  func- 
tions were  relegated  solely  to  the  banking  department. 


258  BANKING  PROGRESS 

With  what  result?  That  the  operations  of  credit,  inde- 
pendent of  the  note-issues,  could,  through  the  banking 
department,  provide  the  most  effective  of  all  media  of 
exchange  (the  deposit-currency);  they  could  expand 
with  trade;  they  could  develop  overtrading  and  crises; 
they  could  produce  all  the  results  formerly  charged  solely 
to  note-issues.  The  unintended  lessons  of  the  Bank 
Act  of  1844  are  the  most  important  in  our  monetary  litera- 
ture. Although  the  act  represented  the  doctrines  of  the 
currency  school,  its  actual  operations  were  the  triumph 
of  the  banking  principle. 

So  with  our  act  of  1913:  while  to  many  the  matter  of 
chief  importance  has  seemed  to  be  the  note-issues,  the 
real  heart  of  the  measure  is  to  be  found  in  the  purely 
banking  functions  of  discount  and  deposit.  Not  only  are 
these  pivotal,  but  they  dominate  the  whole  question  of 
the  note-issues.  In  our  own  country  the  struggles  as- 
sociated with  the  greenbacks  and  silver  have  centred  at- 
tention on  the  circulation  and  the  quantity  of  it  in  use. 
They  have  influenced  the  attitude  toward  bank-notes  by 
leading  some  politicians,  as  before  noted,  to  think  that 
the  issue  of  notes  by  banks  would  enable  these  banks  to 
control  the  "money  market"  and  the  credit  operations 
of  the  country.  Moreover,  the  last  previous  act  (the  so- 
called  Aldrich-Vreeland  Act  of  1908),  intended  to  pro- 
tect the  country  against  possible  panics,  was  based 
throughout  on  the  assumption  that  credit  emergencies 
could  be  met  by  an  issue  of  national  bank  notes  through 
currency  associations.  Yet  in  the  serious  emergencies  in 
the  autumns  of  1912  and  1913,  no  resort  was  made  to  the 
act  of  1908.  Nevertheless,  so  firmly  intrenched  in  the 
minds  of  our  public  men  was  the  belief  in  the  issue  of 
notes  to  relieve  a  crisis  that  in  the  law  of  1913  the  act  of 
1908  was  extended  for  another  year;  and  the  secretary 


THE  FEDERAL  RESERVE  ACT  259 

of  the  treasury  assured  the  country  that  the  act  would 
be  resorted  to  if  necessary. 

As  the  result  of  our  exposition  in  preceding  chapters, 
we  may  at  the  risk  of  repetition  summarize  the  truth  as 
to  notes  and  deposits.  When  a  loan  is  made  by  a  bank 
it  creates  a  demand-Habihty  in  favor  of  the  borrower  that 
can  be  met  either  by  its  own  notes  (or  cash  from  its 
reserves)  or  by  a  deposit-account.  Whether  notes,  or 
checks  drawn  on  deposit-accounts,  are  used  by  the  bor- 
rower depends  on  the  kind  of  transaction,  or  on  the  busi- 
ness habits  of  the  community  where  he  wishes  to  make 
a  payment.  The  elasticity  so  much  extolled  may  be  de- 
manded in  two  different  cases.  In  the  first  place,  the 
seasonal  demand  for  currency  in  the  autumn  had  exposed 
the  inelasticity  of  both  our  note  and  credit  systems.  It 
gave  strong  support  to  those  who  think  our  troubles 
centre  in  the  currency.  Why  ?  Because  in  the  past  the 
demand  both  for  strengthening  reserves  and  for  paying 
customers  has  been  a  demand  for  some  form  of  money. 
Hence  the  emphasis  on  the  need  of  an  elastic  currency; 
and  so  far  as  this  need  of  actual  currency  exists  it  is  of 
course  imperative.  But  this  is  only  a  part  of  the  truth, 
and  not  the  most  important  part  of  it. 

In  the  second  place,  the  demand  which  comes  in  time 
of  a  panic  brings  us  to  the  very  core  of  the  matter.  Here, 
although  to  many  minds  even  panic  conditions  are  sup- 
posed to  demand  treatment  in  the  form  of  additional 
issues  of  notes,  the  real  need  is  for  elasticity  of  credit. 
Where  we  have  the  deposit-currency  well  developed  (as 
in  the  United  States  and  Great  Britain),  there  is  no  lack 
of  a  medium  of  exchange.  Even  in  the  worst  of  the  crisis, 
if  a  borrower  can  obtain  a  loan,  he  has  no  difficulty  in 
getting  a  medium  of  exchange.  Consequently,  the  need 
of  actual  money  is  then  of  importance  primarily  as  it 


260  BANKING  PROGRESS 

affects  the  reserves  of  banks  and  their  lending  power. 
Of  course,  a  bank's  own  notes  cannot  be  used  in  its  re- 
serves. Hence  the  real  need  is  to  stop  the  drain  on  cash 
reserves,  or  to  obtain  that  by  which  reserves  can  be  re- 
plenished. How  can  this  be  done.''  And  how  does  the 
new  act  afford  help  at  this  point.'' 

In  the  past,  the  National  Banking  Act  caused  rigidity 
of  credit  through  its  regulations  touching  not  only  its 
note-circulation  but  also  its  reserves;  and  most  of  all 
by  the  absence  of  all  provisions  for  converting  good  com- 
mercial paper  into  a  means  of  payment — whether  the 
borrower  calls  for  notes  or  uses  a  deposit-account.  That 
is,  the  system  was  so  constructed  that  when  customers 
were  in  the  most  trouble  and  most  needed  help — when 
bank  reserves  were  being  drawn  down — the  bank  was 
obliged  to  refuse  new  loans,  to  contract  existing  loans, 
to  sell  any  available  assets  it  had  for  cash,  and  to  try  to 
increase  the  ratio  of  its  reserves  to  its  demand-liabilities. 
Under  the  new  act,  just  the  reverse  will  be  true.  In 
times  of  distress  there  will  be  no  need  of  contracting 
credit;  in  fact,  the  only  time  when  it  may  be  necessary 
to  contract  credit  will  be  to  check  possible  expansion 
during  a  tendency  to  overtrade  (which  will  be  discussed 
later).  So  far  as  borrowers,  or  the  public,  need  forms  of 
money  in  exchanging  goods,  or  for  various  other  needs. 
Federal  Reserve  notes  can  be  obtained  so  long  as  banks 
holding  good  commercial  paper  demand  such  money. 
Therefore,  irrespective  of  the  elastic  deposit-currency, 
there  will  be  no  inelasticity  of  a  medium  of  exchange  for 
the  public;    it  can  be  had  as  needed,  at  any  time. 

But  how  does  the  act  touch  the  reserves  and  the  re- 
discounts so  that  it  may  bring  about  the  much-desired 
elasticity  of  credit  .f*  This  is  the  nerve-centre  of  the 
whole  act.     The  pivotal  provisions  are  those  which  allow 


THE  FEDERAL  RESERVE  ACT  261 

any  member  bank  to  have  certain  kinds  of  short-time 
paper  rediscounted  at  its  Federal  Reserve  Bank.  At 
this  institution  the  loan  creates  in  favor  of  the  borrowing 
bank  a  deposit-account.  Then  the  pith  of  the  operation 
resides  in  the  fact  that  all  sums  kept  on  deposit  at  a  Re- 
serve Bank  count  as  legal  reserves  for  the  given  member 
bank.  That  is,  the  rigidity  of  credit-banking  in  the  past, 
the  destructive  snatching  for  reserves,  are  displaced  by 
a  system  which  allows  good  commercial  paper — under 
certain  limitations — to  be  converted  into  lawful  reserves. 
This  is  the  process  which  directly  touches  the  lending 
power  of  a  member  bank  to  its  customers.  Therefore, 
in  a  time  of  panic — if  any  such  arrives — there  will  be  no 
reason  for  a  run  on  cash  reserves,  or,  if  there  is  a  sem- 
blance of  it,  there  will  be  a  quick  and  ready  way  by 
which  the  reserves  can  be  replenished.  There  can  be  no 
serious  run  on  the  cash  by  the  public,  because  the  mem- 
ber bank  can  furnish  at  will  reserve  notes,  by  making 
request  for  them  at  the  Reserve  Bank  and  having  them 
charged  against  its  deposit-account  there.  But  it  must 
still  be  kept  in  mind  that  banks  deal  primarily  in  credit, 
and  only  incidentally  in  money.  Goods,  when  sold,  and 
which  form  the  basis  of  commercial  paper,  are  thereby 
coined  into  a  means  of  payment,  and  give  rise  to  their  own 
medium  of  exchange  without  necessarily  calling  on  any 
forms  of  money.  And  yet  the  elasticity  of  the  notes  and 
of  credit  are,  as  they  should  be,  linked  together.  In  short, 
both  notes  and  deposits  (on  which  checks  can  be  drawn) 
respond  directly  to  the  volume  of  commercial  loans;  and 
these  loans  are  directly  related  to  the  general  volume  of 
goods  bought  and  sold.  Thus,  automatically  the  amount 
of  notes  and  the  deposits  adjust  themselves  to  the  needs 
of  trade,  since  either  can  be  had  at  the  choice  of  cus- 
tomers.    This  outcome  is  one  which  no  system  of  notes 


262  BANKING  PROGRESS 

directly  issued  by  a  government  could  possibly  bring 
about. 

The  kind  of  paper  made  acceptable  for  rediscount 
under  the  decree  of  the  Federal  Reserve  Board  is  all- 
important  (Sec.  13).  The  essential  point  in  the  law  is 
the  distinction  between  mercantile  and  investment  paper. 
It  was  not  intended  that  the  paper  presented  for  redis- 
count should  have  been  drawn  to  carry  stocks,  bonds, 
etc.,  or  goods  in  warehouse  held  for  higher  prices;  nor 
to  aid  in  securing  capital  for  fixed  investment  in  irriga- 
tion, water-power,  street-railway,  manufacturing  plant, 
or  similar  purposes.  On  the  other  hand,  it  was  intended 
to  encourage  loans  based  directly  or  indirectly  on  the 
movement  of  goods  from  the  producer  to  the  consumer. 
Granting  this  general  distinction,  there  remains  the  task 
of  stating  just  what  kind  of  paper  in  common  use  con- 
forms to  the  spirit  of  the  act. 

About  thirty  years  ago  a  change  took  place  in  our 
forms  of  paper.  Pre\aousIy,  buyers  of  goods  gave  the 
sellers  their  notes  for  the  allowed  term  of  credit  in  pay- 
ment for  the  goods,  and  these  notes,  usually  indorsed  by 
the  seller,  were  discounted  at  the  banks.  This  was, 
strictly  speaking,  "two-name  commercial  paper."  Un- 
der this  practice,  in  case  of  goods  subsidiary  to  further 
manufacturing  processes  (like  ore,  pig  iron,  steel,  and 
rails)  there  might  be  several  notes  in  the  hands  of  the 
banks  covering  substantially  the  same  goods  at  different 
stages  of  manufacture.  This  usage  has  to-day  practi- 
cally disappeared. 

The  introduction  of  trade  discounts^  made  it  more 
profitable  for  the  buyer  to  borrow  at  his  bank  and  pay 
cash  for  his  goods.  Borrowers  in  good  standing  could 
thus  pay  cash;    while  only  those  of  poor  credit  created 

*  This  has  been  fully  described  supra,  in  Chapter  IV,  §  6. 


THE  FEDERAL  RESERVE  ACT  263 

"commercial  paper."  That  is,  the  one-name  promis- 
sory notes  of  borrowers  in  good  standing  at  the  banks 
were  the  best  paper  offered;  yet  it  was  not  directly  based 
on  the  sale  of  goods.  The  advantage  of  this  method  was 
that  in  effect  it  put  trade  on  a  cash  basis.  This  devel- 
opment, moreover,  seems  to  be  peculiar  to  this  country. 

On  the  other  hand,  the  modern  practice  has  the  dis- 
advantage that  it  is  not  easy  to  know  whether  the  bor- 
rower uses  the  proceeds  of  his  loan  to  pay  for  goods,  or 
whether  he  may  use  it  for  investment  purposes;  or  in 
some  form  that  is  not  liquid.  Moreover,  the  acceptable 
borrower,  once  given  a  certain  line  of  credit,  usually  keeps 
up  to  his  limit  by  renewals,  or  continuous  loans,  without 
periodically  clearing  up  his  account  by  paying  off  his 
loans. 

In  addition  it  should  be  made  clear  that,  besides  the 
notes  thus  described,  a  concern  may  obtain  large  loans 
through  the  agency  of  note-brokers,  who  sell  them  to 
banks.  These  are  the  direct,  unsecured  obligations  of 
the  borrowers.  The  business  of  the  note-broker  has  in- 
creased phenomenally  with  the  growth  of  the  trade  dis- 
count. If  a  borrower  cannot  obtain  cash  to  take  advan- 
tage of  the  trade  discounts,  with  the  aid  of  the  note- 
brokers,  his  standing  is  obviously  low. 

The  Federal  Reserve  Board,  therefore,  not  being  able 
to  alter  business  habits  at  once,  must  try  to  establish 
rules  which  would  admit  the  highest  grade  one-name 
promissory  notes,  but  would  demand  evidence  that  the 
loan  was  not  used  for  investment,  but  for  strictly  mer- 
cantile purposes.  The  discounting  bank  must  be  held 
responsible  for  such  evidence.  In  this  way,  the  spirit  of 
the  act  will  be  recognized,  although  the  paper  is  not 
"strictly  commercial."  Yet  there  will  certainly  arise  a 
tendency  to  devise  forms  of  paper,  which,  while  consis- 


264  BANKING  PROGRESS 

tent  witli  the  existence  of  trade  discounts,  will  disclose 
more  distinctly  than  the  present  promissory  note  the 
purpose  of  the  borrower  to  use  the  loan  for  mercantile, 
and  no  other,  purpose. 

Such  being  the  provisions  of  the  new  act  regarding 
elasticity  of  credit,  are  there  any  dangers  of  expansion? 
Fortunately  the  essential  functions  of  discount  are  not 
hemmed  in  by  detailed  legislative  prohibitions;  fortu- 
nately, one  must  say,  because  discounting  must  always 
remain  a  matter  of  judgment,  and  much  must  be  left  to 
the  management.  Yet,  on  the  other  hand,  this  very 
freedom  from  restraint  might  result,  under  unwise  man- 
agement, in  inflation  and  danger.  This  is  inherent  in 
the  very  nature  of  banking;  since  under  any  system,  good 
or  bad,  everything  depends  upon  the  kinds  of  loans 
made.  And,  of  course,  the  coming  of  war  or  exceptional 
emergencies  cannot  be  foretold. 

Even  with  this  new  act,  it  is  not  to  be  supposed  that 
we  shall  never  see  any  more  crises.  Crises  are  more  or 
less  inevitable,  because  an  act  of  Congress  cannot  pre- 
vent human  optimism  from  overtrading  in  goods.  Thus 
no  matter  how  perfect  is  the  machinery  of  our  credit 
system,  it  will  register  the  spasms  of  trade.  The  essen- 
tial point  to  be  gained  by  a  desirable  system  of  credit  is 
that  it  should  not  aggravate  the  inevitable  disturbances 
which  will  arise  in  emergencies  of  business;  in  the  past, 
our  rigid  laws  magnified  any  departure  from  regular 
conditions.  In  Europe,  the  banking  systems  are  such  as 
to  minimize,  and  not  magnify,  trouble;  which  is  the 
reason  why  Europe  in  recent  times  has  been  free  from  de- 
structive panics,  while  this  country  has  abounded  in  them. 

The  elasticity  of  credit  implies  both  expansion  and 
contraction  according  to  the  needs  of  business.  Since 
any  loan  may  be  carried  through  by  a  bank  giving  either 


THE  FEDERAL  RESERVE  ACT  265 

its  own  notes  (or  other  cash)  or  a  deposit-account,  ex- 
pansion may  be  effected  either  by  an  overissue  of  notes 
or  by  an  excessive  creation  of  deposit-accounts.  In  some 
quarters,  it  is  assumed  that  expansion  can  be  regulated 
by  regulating  the  issue  of  notes,  or  by  taxing  them,  or 
the  like.  This  is  not  true  to  the  extent  supposed.  As 
a  medium  of  exchange  in  paying  wages,  for  travelling 
expenses,  and  for  retail  transactions,  a  certain  sum  of 
notes  is  always  needed;  but  amounts  beyond  that  will 
normally  return  to  the  banks.  If  the  notes  could  be  used 
as  reserves,  they  would  enable  banks  to  expand  loans. 
But  Federal  Reserve  notes  cannot  be  used  as  reserves  by 
member  banks;  and  here  is  a  check  on  undue  expansion. 
The  danger,  however,  may  exist  elsewhere;  these  notes, 
like  present  national  bank  notes,  could  be  used  by  the 
17,000  or  more  State  institutions  in  their  reserves.  So 
much,  for  present  purposes,  as  to  expansion  through  the 
notes  (which  are  not  limited  in  amount). 

Those  loans,  it  should  be  noted,  which  result  in  deposit- 
accounts  at  Federal  Reserve  Banks  (and  which  are  not 
drawn  down  by  requests  for  notes)  directly  increase  the 
reserves  of  member  banks  until  transferred  by  check. 
Thus  the  lending  power  of  the  member  bank  is  more 
quickly  and  extensively  enlarged  by  this  process  than  by 
the  issue  of  notes.  Herein  lies  the  pivotal  question  of 
overexpansion.  Passing  by  the  question  of  overexpan- 
sion  through  the  issue  of  notes,  it  is  desired  mainly  to 
study  here  that  arising  only  from  the  use  of  deposit- 
accounts  and  checks,  because  these  operations  are  less 
understood  and  are  more  elusive.  Here  the  possibility 
of  expansion  is  even  greater  than  in  connection  with 
notes,  because  the  proceeds  of  a  loan  at  a  Reserve  Bank, 
if  left  there,  at  once  count  as  reserves,  and  permit  another 
increase  of  loans. 


266  BANKING  PROGRESS 

To  this  possibility  of  serious  expansion,  what  are  the 
practical  checks  to  be  found  in  the  bill?  They  may 
briefly  be  listed  as  follows: 

1.  Against  notes  the  Reserve  Bank  must  carry  40  per  cent 
gold  reserves;  and  against  deposits  35  per  cent  reserves  in 
gold  or  lawful  money.  But  expansion  will  first  develop  in  the 
member  banks.  They  are  not  required  to  keep  as  large  re- 
serves as  before  against  deposits  (carrying,  of  course,  no  re- 
serves for  notes).  They  can  make  more  profit  with  the  same 
reserves  by  carrying  more  loans.  Thus,  there  is  no  restriction 
here,  except  that  of  refusal  of  loans  by  the  Reserve  Bank. 

2.  In  Europe  the  real  control  over  expansion  is  in  the  rate 
of  discount  charged  to  the  borrower.  So  must  it  be  here,  if  it 
is  raised  early  and  not  after  the  expansion  has  arrived;  but 
watch  must  be  kept  on  the  particular  bank  beginning  to  ex- 
pand its  loans,  and  the  treatment  must  be  individually  applied 
at  the  source.     (See  Sec.  5  of  Proposed  Bill,  p.  172.) 

3.  A  still  more  important  check  resides  in  the  provision  (sec. 
13)  that  Reserve  Banks  shall  rediscount  only  "notes,  drafts, 
and  bills  of  exchange  arising  out  of  actual  commercial  transac- 
tions," having  a  maturity  of  not  over  90  days;  although  a 
limited  amount  of  live-stock  paper  may  have  a  maturity  not 
exceeding  six  months.  The  final  definition  of  all  such  paper  is 
left  to  the  Reserve  Board.  But  loans  secured  by  investment 
security  cannot  be  rediscounted  except  in  the  case  of  United 
States  securities.  The  spirit  of  the  act,  as  already  explained, 
forbids  loans  for  such  purposes  as  carrying  goods  in  storage  for 
a  higher  price,  and  should  confine  loans  to  paper  based  on  goods 
actually  sold.  Just  how  to  define  such  paper  lays  a  heavy  re- 
sponsibility on  the  Federal  Board.  On  it  will  finally  depend 
the  kind  of  assets  allowed  to  Reserve  Banks.  (See  infra,  pp. 
279  ff.) 

4.  A  real  restriction  exists  in  making  rediscounts  on  only 
short-time  paper;  but  90  days  is  somewhat  too  long  for  the 
best  Hquidity  of  assets.  It  was  asserted,  however,  that  coun- 
try banks  would  gain  no  advantage  by  the  new  system,  because 
they  had  little  or  no  short-time  paper.  By  the  call  of  the 
Comptroller,  August  9,  1913,  it  was  disclosed  that  the  report- 
ing national  banks  held  loans  of  $3,427,055,157  maturing  in 


THE  FEDERAL  RESERVE  ACT  267 

90  days,  and  $2,594,351,440  maturing  in  a  longer  period;  or 
58  per  cent  of  the  former,  and  42  per  cent  of  the  latter.  The 
6,736  country  banks  (outside  central  reserve  and  reserve  cities) 
held  $1,735,000,000  loans  having  a  maturity  of  90  days  or  less, 
and  $1,337,000,000  maturing  over  90  days.  That  is,  even 
country  banks  hold  more  short-time  than  long-time  paper. 
There  is  obviously  enough  paper  to  allow  of  expansion,  so  far 
as  quantity  goes.  The  real  check  must  be  in  passing  on  the 
quality  of  the  paper. 

5.  The  exclusion  of  investment  paper  should  cut  off  all  pos- 
sibility of  expansion  by  stock-exchange  speculation  through  the 
help  of  rediscounts  at  Reserve  Banks.  It  is  to  be  remembered, 
however,  that  any  member  bank  can  still  loan  on  stock-exchange 
collateral  to  the  extent  that  it  does  not  wish  for  rediscounts; 
and  that  all  state  institutions  not  members  can  loan  on  such 
collateral.  We  have  not,  therefore,  seen  the  end  of  stock 
speculation. 

6.  Rediscounts  at  the  Reserve  Banks  must  be  indorsed  by 
the  borrowing  bank.     Hence  there  will  be  some  check  here. 

7.  Also,  no  member  bank  may  loan  more  than  10  per  cent 
of  its  capital  and  surplus  to  any  one  person  or  firm.  This  was 
later  amended.     (Cf.  p.  279,  n.  2.) 

8.  A  real  check  is  found  in  the  restriction  of  discounts  on 
acceptances  in  the  original  act  to  those  based  on  importation 
or  exportation  of  goods;  and  even  these  shall  not  exceed  one- 
half  the  paid-up  capital  and  surplus  of  the  borrowing  member 
bank.  The  original  omission  of  domestic  acceptances  was  a 
serious  handicap  to  the  desired  discount  market,  but  for  a  while 
it  worked  toward  a  restriction  of  potential  expansion. 

9.  In  practice  the  paper  must  pass  rigid  scrutiny  in  more 
than  one  step.  First,  it  must  satisfy  the  member  bank;  second, 
it  must  be  satisfactory  to  the  Reserve  Bank;  and,  thirdly,  if 
notes  are  wanted,  it  must  pass  the  judgment  of  the  Agent  of 
the  Reserve  Board. 

10.  The  power  of  the  Reserve  Board  to  examine  into  the 
operations  of  reserve  banks,  and  the  frequent  or  special  examina- 
tions of  member  banks,  will  give  an  important  control  over  ex- 
pansion, or  unsound  banking,  if  legitimately  used  (sees.  21,  22). 

11.  Again,  it  is  to  be  noted  that,  in  rediscounting,  a  large 
number  of  individual  banks  will  be  related  to  each  other  in 


268  BANKING  PROGRESS 

a  co-operative  fashion.  Something  of  an  institutional  char- 
acter has  been  introduced,  and  it  is  possible  to  place  respon- 
sibility here  and  there  as  was  never  possible  before.  This  de- 
velopment should  gradually  and  by  experience  prove  of  im- 
portance in  controlling  overexpansion. 

12.  Finally,  if  fear  arises  from  the  absence  of  any  limit  on 
note-issues,  it  is  to  be  remembered  that  the  Reserve  Board  can 
impose  a  tax  upon  them  at  their  discretion,  which  tax  will  be 
added  to  the  rate  of  discount  to  the  borrower.  Such  a  pro- 
vision should  accomplish  the  time-honored  purpose  of  the 
European  taxes  on  notes  passing  a  certain  limit.  To  remove 
all  limits  on  notes  was  right;  but  it  was  a  courageous  thing  to 
put  it  in  the  bill,  because  many  people  think  expansion  is  largely 
to  be  attributed  to  the  quantity  of  issues.  Trouble  is  less  likely 
in  normal  times  to  arise  from  the  notes  than  from  the  possible 
use  of  deposit-accounts  following  loans  which  demand  only 
checks  as  a  medium  of  exchange. 

It  must  be  emphasized  that  the  possibilities  of  undue 
expansion  of  credit  cannot  be  removed  by  any  legal 
provisions  in  an  act.  It  may  create  machinery,  but  the 
speed  with  which  it  will  be  run  will  depend  upon  the 
judgment  of  the  man  at  the  throttle.  Elasticity  of  credit 
has  been  given  us  with  all  its  possibilities  of  good  to 
business,  together  with  all  its  possibilities  for  abuse. 
The  whole  safety  of  our  credit  fabric,  therefore,  rests 
upon  those  who  pass  on  the  paper  discounted.  Conse- 
quently, the  success  of  the  new  system  depends  chiefly 
on  the  men  selected  to  manage  the  several  Reserve  Banks. 
In  practical  operation,  they  are  more  important  than 
those  on  the  Reserve  Board. 

§  8.  The  new  act  has  made  possible  a  departure  of 
very  great  importance  in  the  technical  methods  of 
clearings  and  collections.  It  is  a  further  development  of 
economizing  devices  in  the  settlement  of  credits.  For  a 
long  time  the  charges  of  clearing-houses  have  been  a 


THE  FEDERAL  RESERVE  ACT  269 

source  of  dissatisfaction.  The  original  field  of  clearing- 
houses was  limited  to  local  banks  in  one  city,  but  later 
it  was  extended  somewhat  by  such  a  system  as  that  in- 
augurated by  Boston,  Kansas  City,  and  some  other  cities. 
In  the  new  act  larger  questions  of  joint  action  over  wide 
districts,  or  even  over  the  whole  country,  are  raised. 
The  problem  is :  Can  the  gains  of  city  clearing-houses  and 
collections  be  extended  to  the  whole  territory  of  the 
United  States  .^^ 

All  the  original  regulations  touching  this  matter  in 
the  act^  are  as  follows: 

Any  Federal  reserve  bank  may  receive  from  any  of  its  mem- 
ber banks,  and  from  the  United  States,  deposits  of  current 
funds  in  lawful  money,  national-bank  notes.  Federal  reserve 
notes,  or  checks  and  drafts  upon  solvent  member  banks,  pay- 
able upon  presentation;  or,  solely  for  exchange  purposes,  may 
receive  from  other  Federal  reserve  banks  deposits  of  current 
funds  in  lawful  money,  national-bank  notes,  or  checks  and 
drafts  upon  solvent  member  or  other  reserve  banks,  payable 
upon  presentation  (sec.  13). 

Every  Federal  reserve  bank  shall  receive  on  deposit  at  par 
from  member  banks  or  from  Federal  reserve  banks  checks  and 
drafts  drawn  upon  any  of  its  depositors,  and  when  remitted 
by  a  Federal  reserve  bank,  checks  and  drafts  drawn  by  any 
depositor  in  any  other  Federal  reserve  bank  or  member  bank 
upon  funds  to  the  credit  of  said  depositor  in  said  reserve  bank 
or  member  bank.  Nothing  herein  contained  shall  be  construed 
as  prohibiting  a  member  bank  from  charging  its  actual  expense 
incurred  in  collecting  and  remitting  funds,  or  for  exchange 
sold  to  its  patrons.  The  Federal  Reserve  Board  shall,  by  rule, 
fix  the  charges  to  be  collected  by  the  member  banks  from  its 
patrons  whose  checks  are  cleared  through  the  Federal  reserve 
bank  and  the  charge  which  may  be  imposed  for  the  service  of 
clearing  or  collection  rendered  by  the  Federal  reserve  bank 
(sec.  16). 

'  Later  these  were  amended,  March  3,  1915,  September  7,  1916,  and  June 
21.  1917. 


270  BANKING  PROGRESS 

In  these  sections,  in  spite  of  some  blundering  due  to  a 
compromise  on  technical  questions,  and  from  a  desire  to 
conciliate  country  banks  (whose  earnings  are  largely 
affected  by  charges  for  collections),  some  important  ad- 
vances were  made:  any  Federal  Reserve  Bank  may  re- 
ceive on  deposit  from  its  members  or  from  the  United 
States  cheeks  and  drafts  drawn  on  any  solvent  member 
bank;  "for  exchange  purposes"  any  Federal  Reserve 
Bank  may  accept  from  any  other  Reserve  Bank  checks 
and  drafts  drawn  on  any  solvent  member  bank  or  other 
Reserve  Bank;  but  it  is  said  (Sec.  16)  that  such  items 
shall  be  received  at  par;  while  elsewhere  certain  charges 
are  allowed  for  collecting  them,  which  has  been  inter- 
preted by  exchange  experts  as  making  no  charge  for  ex- 
change, but  allowing  a  charge  for  cost  of  service.  But 
independent  of  "exchange  purposes,"  any  Reserve  Bank 
must  receive  at  par  from  member  banks,  or  from  other 
Reserve  Banks,  checks  and  drafts  drawn  on  any  mem- 
ber bank  in  the  system,  that  is,  without  a  charge  for 
exchange;  but  yet  a  member  bank  is  not  to  be  prohibited 
from  charging  actual  expenses  for  collection  or  exchange 
to  its  patrons. 

The  Reserve  Board  is  to  fix  the  charges  levied  by 
member  banks  on  patrons  if  these  checks  are  cleared 
through  a  Reserve  Bank,  and  also  to  fix  the  charge  of  the 
Reserve  Bank  for  its  cost  of  clearing  or  collection. 

Bearing  directly  on  a  future  system  of  clearings  for 
the  whole  country.  Sec.  16  provides  as  follows: 

The  Federal  Reserve  Board  shall  make  and  promulgate  from 
time  to  time  regulations  governing  the  transfer  of  funds  and 
charges  therefor  among  Federal  reserve  banks  and  their  branches, 
and  may  at  its  discretion  exercise  the  functions  of  a  clearing 
house  for  such  Federal  reserve  banks,  or  may  designate  a  Fed- 
eral reserve  bank  to  exercise  such  functions,  and  may  also  re- 


THE  FEDERAL  RESERVE  ACT  271 

quire  each  such  bank  to  exercise  the  functions  of  a  clearing 
house  for  its  member  banks. 

Since  a  member  bank  will  have  reserves  in  its  Reserve 
Bank,  a  balance  in  the  clearings  by  a  Reserve  Bank  against 
a  member  bank  can  be  directly  charged  against  the  ac- 
coimt  of  said  member  bank,  and  all  charges  for  collec- 
tion would  be  avoided.  Any  cost  for  handling  these 
clearings  could  be  charged  by  the  Reserve  Bank  against 
member  banks.  A  saving  over  the  present  methods  is 
thus  possible.  How  far  a  wide-reaching  system  of  clear- 
ings may  be  developed,  in  spite  of  the  extensive  clerical 
service  required,  depends  largely  on  organization  and 
future  dispositions.  It  is  possible  that  the  present  city 
clearing-houses  may  be  superseded. 

There  is,  under  the  new  law,  a  discrimination  in  favor 
of  a  check  drawn  on  any  member  bank:  in  the  future  it 
should  be  received  at  par  in  any  part  of  the  country 
equally  with  New  York  or  Chicago  exchange.  There- 
fore all  past  methods  of  drawing  exchange  are  to  a  certain 
extent  likely  to  be  upset.  Certainly  checks  on  non- 
member  banks  will  be  discriminated  against,  and  they 
must  go  through  the  old  process  of  collection,  which  will 
not  be  so  quick  or  so  inexpensive  as  that  of  member  banks. 
Competition  of  non-member  banks  may  lower  the  cost, 
or  checks  on  non-member  banks  may  be  collected  by  de- 
positing checks  of  non-member  banks  with  member  banks. 

The  use  of  checks  drawn  by  individuals  on  their  local 
banks  to  make  payments  even  of  small  sums  in  any 
part  of  the  country  lies  at  the  bottom  of  the  extensive 
system  of  collections  and  clearings  in  the  United  States. 
In  Europe  this  burden  is  largely  escaped  by  being  thrown 
on  remittances  through  banks.  The  new  act  clinches 
the  present  habit,  and  makes  it  permanent,  by  supply- 
ing the  means  of  continuing  it. 


272  BANKING  PROGRESS 

§  9.  It  had  been  hoped  by  the  friends  of  the  National 
Monetary  Commission  Plan  to  introduce  in  this  country 
a  discount  market  such  as  exists  in  the  financial  centres 
of  Europe.  A  discount  market  obviously  means  a  mar- 
ket where  certain  kinds  of  paper  can  be  sold  at  any  time. 
To  suit  paper  for  such  a  market  it  must  have  universal 
acceptability  by  having  a  maker  whose  credit  is  accepted 
in  any  market.  Established  institutions,  rather  than 
private  persons,  are  likely  to  be  thus  recognized.  Prom- 
issory notes,  the  usual  paper  discounted  in  this  coun- 
try, are  the  promises  of  individuals  or  firms,  and  therefore 
have  no  wide  recognition.  The  process  of  making  an 
acceptance  is  as  follows:  The  person  wishing  credits 
will  go  to  a  large  mercantile  house,  or  bank,  and  ask  the 
privilege  of  drawing  a  bill  on  it,  falling  due  at  a  date  in 
the  future,  which  will  be  accepted  by  them  on  presen- 
tation. The  house,  or  bank,  writes  across  the  face  of 
the  bill  the  word  "accepted,"  with  the  date  and  its  sig- 
nature. A  promise  to  pay  in  the  future  to  a  bank  and 
"accepted"  by  it  has  the  security  and  recognition  of 
the  acceptor.  Hence,  the  use  of  acceptances  has  been 
urged  as  necessary  to  the  existence  of  a  discount  market 
in  this  country. 

Hitherto,  acceptances  had  not  been  permitted  by  law 
to  national  banks.  Under  the  new  act  our  banks  were 
allowed  to  accept,  as  follows: 

Any  member  bank  may  accept  drafts  or  bills  of  exchange 
drawn  upon  it  and  growing  out  of  transactions  involving  the 
importation  or  exportation  of  goods  having  not  more  than  six 
months  sight  to  run;  but  no  bank  shall  accept  such  bills  to 
an  amount  equal  at  any  time  in  the  aggregate  to  more  than 
one-half  its  paid-up  capital  stock  and  surplus  (sec.  13).^ 

^  Amended,  March  3,  1915,  to  equal  the  stock  and  surplus. 


II 


THE  FEDERAL  RESERVE  ACT  273 

The  limitation  of  acceptances  to  transactions  in  for- 
eign trade,  and  the  omission  of  authority  to  make  ac- 
ceptances based  on  domestic  transactions,  obviously 
limited  the  supply  of  paper  which  could  be  offered  in  a 
general  discount  market.  The  reason  for  such  omission 
was  the  fear  of  undesirable  expansion,  if  the  right  to  ac- 
cept were  given  free  rein.  In  all  cases  the  customer  ask- 
ing for  the  acceptance  agrees  to  provide  the  accepting 
bank  with  funds  to  cover  the  acceptance  on  or  before 
the  day  it  falls  due.  The  acceptor  only  lends  his  credit, 
to  the  customer,  and  does  not  advance  any  cash.  Hence 
in  accepting  a  bill  drawn  on  it  a  bank  would  not  create 
a  liability  by  a  deposit-account  against  which  it  must 
carry  reserves;  and  in  this  country  the  temptation  to 
accept  beyond  moderation  might  have  been  too  strong 
to  be  resisted,  if  a  curb  were  not  introduced.  As  the  law 
stood,  a  limited  use  of  acceptances  was  permitted,  which 
might  be  extended  by  later  legislation,  provided  tradi- 
tions of  safety  were  thereafter  established.  Moreover, 
it  is  doubtful  if  bills  of  exchange  drawn  on  the  actual 
movement  of  goods,  or  bills  drawn  on  banks,  in  order 
to  provide  acceptances  could  be  extended  to  such  an 
extent  in  this  country  as  to  supplant  the  promissory  note. 

Besides  the  general  market  for  acceptances,  the  new 
act  permitted  Federal  Reserve  Banks  to  deal  in  them: 

Any  Federal  reserve  bank  may  discount  acceptances  which 
are  based  on  the  importation  or  exportation  of  goods  and  which 
have  a  maturity  at  time  of  discount  of  not  more  than  three 
ironths,  and  indorsed  by  at  least  one  member  bank.  The 
amount  of  acceptances  so  discounted  shall  at  no  time  exceed 
one-half  the  paid-up  capital  stock  and  surplus  of  the  bank  for 
which  the  rediscounts  are  made  (sec.  13). 

If  our  acceptances  based  on  cotton,  for  instance,  were 
made  salable  in  London,  or  on  the  Continent,  they  would 


274  BANKING  PROGRESS 

in  effect  provide  a  means  of  bringing  in  foreign  capital 
to  finance  the  movement  of  our  crop.  This  would  be  an 
obvious  advantage. 

In  other  respects,  the  purpose  of  seUing  acceptances  in 
a  discount  market  would  be  to  change  the  assets  of  the 
holder  into  cash.  So  far  as  member  banks  wish  to  do 
this,  they  may  obtain  the  end  in  another  way,  by  redis- 
counting  paper  with  a  Federal  Reserve  Bank;  but  such 
operations  are  limited  by  the  resources  of  capital  at  the 
disposal  of  the  Reserve  Banks. 

§  10.  So  far  as  Americans  are  engaged  in  foreign  trade, 
or  are  located  in  foreign  countries,  they  labor  under  some 
disadvantage,  if  they  are  obliged  to  do  their  business 
through  foreign  banking  institutions.  In  international 
relations,  and  in  granting  of  loans,  the  trade  of  any  one 
country  is  usually  favored  by  the  institutions  owned  by 
the  citizens  of  that  country.  Our  business  men  are  not 
so  well  known  that  they  can  obtain  loans  from  foreign 
banking-houses  in  Buenos  Aires  or  Hongkong  as  favorably 
as  those  who  have  been  long  known  to  their  commercial 
and  banking  institutions.  A  young  country  must  fight 
for  its  recognition  in  trade;  and  it  needs  the  support 
abroad  of  its  own  powerful  banking  institutions. 

Moreover,  American  bankers  were  obliged  to  share 
commissions  with  foreign  bankers  on  an  immense  amount 
of  international  trade  originating  with  us.  Formerly 
American  drafts  and  bills,  if  sent  abroad  in  payment  of 
imports  from  Europe,  could  not  be  sold  in  the  discount 
markets  of  Europe,  because  the  American  firms  were 
not  suflSciently  well  known. 

As  soon  as  our  foreign  trade  warrants  it,  and  as  soon 
as  we  have  capital  enough  so  that  a  surplus  can  be  em- 
ployed out  of  the  country,  foreign  banking  branches,  if 


II 


THE  FEDERAL  RESERVE  ACT  275 

profitable,  will  come  into  being  under  the  provisions  of 
the  new  act  (Sec.  25).  Such  branches  are  permitted  to 
national  banks  having  a  capital  and  surplus  of  $1,000,000 
or  more,  subject  to  examination  by  the  Federal  Reserve 
Board,  and  provided  the  accounts  of  each  branch  are 
kept  separately  from  those  of  any  other  branch.^ 

§  11.  As  regards  the  independent  treasury  system, 
the  act  has,  unfortunately,  brought  no  definite  removal 
of  the  possibilities  of  past  evils.  Not  only  were  more 
important  matters  attracting  chief  attention  in  the  bill, 
but  also  there  was  an  evident  purpose  in  the  administra- 
tion to  retain  in  its  hands  as  much  power  as  possible  over 
the  money  market.  Hence  the  act  was  only  permissive 
in  the  provision  (Sec.  15)  for  the  deposit  of  government 
funds  with  the  banks  of  the  new  system: 

The  moneys  held  in  the  general  fund  of  the  Treasury,  except 
the  five  per  centum  fund  for  the  redemption  of  outstanding 
national-bank  notes  and  the  funds  provided  in  this  act  for  the 
redemption  of  Federal  Reserve  notes,  may,  upon  the  direction 
of  the  Secretary  of  the  Treasury,  he  deposited  in  Federal  Re- 
serve Banks,  which  banks,  when  required  by  the  Secretary  of 
the  Treasury,  shall  act  as  fiscal  agents  of  the  United  States; 
and  the  revenues  of  the  Government  or  any  part  thereof  may 
be  deposited  in  such  banks,  and  disbursements  may  be  made 
by  checks  drawn  against  such  deposits. 

No  public  funds  of  the  Philippine  Islands,  or  of  the  postal 
savings,  or  any  Government  funds  shall  be  deposited  in  the 
continental  United  States  in  any  bank  not  belonging  to  the 
system  established  by  this  act ;  Provided,  however,  that  nothing 
in  this  act  shall  be  construed  to  deny  the  right  of  the  Secretary 
of  the  Treasury  to  use  member  banks  as  depositories. 

Nevertheless,  there  is  so  general  and  subconscious  an 
understanding  of  the  undesirability  of  withdrawing  gov- 

*  Amended,  September  7,  1916,  sec.  14  (e). 


276  BANKING  PROGRESS 

ernment  funds  from  the  money  market  that  public  opin- 
ion would  doubtless  enforce  a  rational  policy  on  the 
Treasury  at  all  times;  but  the  act  leaves  the  avoidance 
of  evil  solely  to  the  personal  will  of  the  secretary. 

§  12.  It  should  be  remembered,  however,  that  it 
was  possible  under  this  act  to  require  membership  only 
of  national  banks.  At  the  time  of  its  passage  there  were 
more  than  twice  as  many  banks  out  of  the  system  as  in 
it.^  Therefore,  the  relations  of  the  national  to  the  State 
banks  and  trust  companies  were  important  and  had  to 
be  reckoned  with.  The  liabilities  of  the  national  banks 
to  these  outside  institutions  amounted  to  over  $1,200,- 
000,000;  while  there  was  due  from  them  to  national 
banks  a  sum  nearly  half  as  large  as  from  other  national 
banks.  The  desirability  of  creating  a  situation  such 
that  the  State  banks  should  find  it  to  their  interest  vol- 
untarily to  join  the  system  was  early  recognized.  The 
provisions  of  Sec.  9  did  not  bring  this  about.  The  greater 
freedom  from  examinations  and  reports  and  the  less 
stringent  requirements  regarding  reserves  and  kinds  of 
business  done  enjoyed  by  State  banks  gave  them  cer- 
tain advantages  in  remaining  out  of  the  system.  More- 
over, existing  provisions  of  State  laws  hindered  the  ac- 
ceptance of  the  new  act  by  State  banks.  On  the  other 
hand,  the  rise  of  a  great  emergency,  like  war,  would  make 
a  disunited  banking  system  a  source  of  danger  where 
unity  of  regulation  and  action  might  be  a  source  of 
strength  to  the  credit  of  the  country.  In  a  time  of  stress 
many  State  banks  must  undoubtedly  rely  for  aid  directly 
or  indirectly  on  the  Reserve  Banks.  Sooner  or  later — 
as  in  the  early  struggle  after  1864  between  the  new  na- 

*  By  1917  only  about  one-half  the  banking  resources  of  the  country  were  in- 
cluded in  the  Federal  Reserve  system. 


THE  FEDERAL  RESERVE  ACT  277 

tional  banks  and  the  State  banks — one  or  the  other  must 
inevitably  take  the  lead.  It  is  certain  that  the  logic  of 
events  will  bring  the  larger  part  of  the  State  banks  into 
the  Federal  Reserve  system. 

There  are  many  other  matters  which  might  be  touched 
upon  in  connection  with  the  new  law;  but  within  our 
limits  it  has  been  possible  to  discuss  only  the  chief  topics 
selected.  There  are  unfortunate  provisions  in  the  act, 
such  as  those  in  Sec.  24,  permitting  loans  on  farm  lands 
by  banks  that  create  demand-liabilities.  They  should 
not  tie  up  their  resources  in  an  unliquid  form  like  loans 
on  land.  But  the  sum  and  substance  of  the  whole  act 
is  so  remarkably  good,  that  the  combined  support  of 
both  bankers  and  the  public  is  certain  to  be  given  to  it 
to  the  end  that  it  may  work  smoothly  and  bring  a  long- 
desired  reform  to  an  expectant  nation. 


CHAPTER  XI 
WORKING  OF  THE  FEDERAL  RESERVE  ACT 

§  1.  The  inauguration  of  a  new  banking  system,  in- 
volving many  departures  from  established  methods,  in- 
evitably necessitated  interpretations  and  adjustments 
largely  administrative  in  character.  Practical  experi- 
ence also  showed  the  need  of  amendments  to  the  law. 
Beyond  these  in  importance  came  the  test  of  the  essen- 
tial principles  on  which  the  act  was  based,  particularly 
when  tried  out  in  the  exceptional  conditions  produced  by 
the  European  War.  No  banking  system  could  have 
been  subjected  to  a  harder  test;  and  it  would  be  strange 
if  it  had  not  disclosed  some  weaknesses  either  of  policy 
or  of  structure. 

Although  the  act  was  passed  seven  months  before  the 
outbreak  of  the  war,  it  was  nearly  eleven  months  before 
the  system  began  operations  (November  16,  1914).  For 
this  delay  there  are  none  but  political  excuses.  It  was 
not  until  August  10,  1914,  that  the  Federal  Reserve  Board 
took  the  oath  of  oflBce.  The  panic  of  1914  forced  the 
organization  that  should  have  been  completed  months 
before.  The  subconscious  belief  in  the  new  system  al- 
ready enacted  served  at  the  best  to  produce  only  a  psy- 
chological steadying  effect  in  the  summer  of  1914.^ 

The  Reserve  Bank  Organization  Committee  had  al- 
ready located  the  twelve  districts,  designated  the  seat  for 
each  Reserve  Bank,  and  secured  the  election  of  their  di- 
rectors. There  early  arose  the  need  of  defining  the  kinds 
of  paper  to  be  discounted  by  the  Reserve  Banks  for  their 

1  See  Laughlln,  Credit  of  the  Nations,  pp.  297-306,  350-353,  for  the  situation 
duriag  the  panic  of  1914. 

278 


WORKING  OF  FEDERAL  RESERVE  ACT    279 

members.  After  a  series  of  orders,  a  final  regulation  of 
the  Federal  Reserve  Board  was  issued  June  22,  1917,^ 
superseding  previous  ones,  thus  defining  the  paper  which 
could  be  rediscounted  under  Sec.  13: 

Notes,  drafts,  or  bills  of  exchange,  of  not  more  than 
ninety  days;  made  for  agricultural  (six  months),  indus- 
trial, or  commercial  purposes,  and  not  for  carrying  securi- 
ties (except  those  of  the  United  States);  the  aggregate 
of  any  one  borrower  not  to  exceed  10  per  cent^  of  the 
bank's  capital  and  surplus  (except  bills  drawn  against 
actually  existing  values);  indorsed  by  a  member  bank, 
and  the  proceeds  of  which  are  not  to  be  used  for  fixed 
investments,  such  as  land,  building,  or  machinery. 

A  promissory  note  is  defined  as  an  unconditional  promise, 
in  writing,  signed  by  the  maker,  to  pay  in  the  United 
States,  at  a  fixed  or  determinable  future  time,  a  sum 
certain  in  dollars  to  order  or  to  bearer. 

A  draft  or  hill  of  exchange  is  an  unconditional  order  in 
writing,  addressed  by  one  person  to  another  other  than 
a  banker,  signed  by  the  person  giving  it,  requiring  the 
person  to  whom  it  is  addressed  to  pay,  in  the  United 
States,  at  a  fixed  and  determinable  future  time,  a  sum 
certain  in  dollars  to  the  order  of  a  specified  person. 

A  trade  acceptance  is  a  draft  or  bill  of  exchange  drawn 
by  the  seller  on  the  purchaser  of  goods  sold  and  accepted 
by  such  purchaser.^ 

Agricultural  paper,  which  has  a  maturity  of  not  more 
than  six  months,  is  a  note,  draft,  bill  of  exchange,  or 
trade  acceptance,  the  proceeds  of  which  have  been  used, 

1  Bulletin,  July,  1917,  pp.  539-543. 

^  To  further  the  placing  of  government  bonds  this  restriction  was  raised  un- 
der certain  conditions  to  20  per  cent  by  the  act  of  March  3,  1919.  Bulletin, 
March,  1919,  p.  229. 

2  For  terms  of  sale  in  the  principal  industries,  see  Bulletin,  December,  1919, 
p.  1129,  and  later  issues. 


280  BANKING  PROGRESS 

or  are  to  be  used,  for  agricultural  purposes,  including  the 
breeding,  raising,  fattening,  or  marketing  of  live  stock. 

Commodity  paper^  is  a  note,  draft,  bill  of  exchange,  or 
trade  acceptance,  accompanied  and  secured  by  shipping 
documents  or  by  a  warehouse,  terminal,  or  other  similar 
receipt  covering  approved  and  readily  marketable,  non- 
perishable  staples,  properly  insured  (September  3,  1915). 

A  hanker^s  acceptance  is  a  draft,  or  bill  of  exchange,  of 
which  the  acceptor  is  a  bank  or  trust  company,  or  a  firm, 
person,  company,  or  corporation  engaged  in  the  business 
of  granting  banker's  acceptance  credits. 

Paper  of  the  above  descriptions,  properly  eligible,  may 
be  discounted  by  any  Federal  Reserve  Bank  for  any  of 
its  member  banks. 

Another  form  of  paper  produced  far-reaching  effects 
during  the  war.  By  act  of  September  7,  1916,  a  Federal 
Reserve  Bank  was  allowed  to  loan  directly  to  a  member 
bank  on  its  fifteen-day  promissory  note,  secured  by  such 
notes,  drafts,  bills  of  exchange,  or  bankers'  acceptances 
as  are  eligible  for  rediscount  or  for  purchase  by  Federal 
Reserve  Banks,  or  by  the  deposit  or  pledge  of  bonds  or 
notes  of  the  United  States.^  The  use  of  this  device 
helped  to  expand  loans  on  collateral  of  our  government's 
war  obligations  to  prodigious  sums. 

Under  former  banking  habits,  rediscounting  of  its 
customers'  paper  by  a  bank  had  been  regarded  as  a  mark 
of  weakness.  Under  the  new  act  that  came  to  be  the 
usual  resort  of  member  banks  wishing  to  enlarge  reserves. 
At  first,  however,  there  had  been  a  release  of  old  reserves, 
the  beginning  of  an  inflow  of  gold  during  1915,  and,  in 
a  tide  of  general  prosperity,  little  need  for  rediscounting. 
There  was  little  to  indicate  the  coming  of  unprecedented 

*  Merged  with  other  paper,  cf.  p.  28-1,  n.  1. 

*  April  5, 1918,  bonds  or  notes  of  the  War  Finance  Corporation  were  included. 


WORKING  OF  FEDERAL  RESERVE  ACT    281 

burdens  after  we  entered  the  war.  In  providing  perhaps 
$30,000,000  of  discounts  by  the  end  of  1915  there  was  no 
hint  of  the  record  figure  of  over  $8,000,000,000  during 
October,  1919. 

Much  attention  was  given  to  the  introduction  of  ac- 
ceptances among  the  short-time  paper  which  could  be 
presented  to  the  Federal  Reserve  Banks  for  rediscount 
or  bought  in  the  open  market.  It  was  a  matter  of  slow 
education  in  a  community  to  which  that  form  of  paper 
was  new.^  In  our  foreign  trade  acceptances  were  more 
or  less  familiar,  and  as  a  cautious  beginning  they  were 
made  available  for  discount  in  the  original  act.  In  the 
first  year  or  so  there  was  a  feeling  that  the  system  should 
be  coddled  to  enable  it  to  earn  dividends.  In  the  original 
act,  acceptances  could  not  be  rediscounted  for  a  member 
bank  to  an  amount  exceeding  one-half  its  capital  and 
surplus.  Very  soon  the  Federal  Reserve  Board  was  au- 
thorized, under  certain  conditions,  to  permit  such  ac- 
ceptances to  100  per  cent  of  their  capital  and  surplus. ^ 
Later,  domestic  acceptances  were  made  available,  pro- 
vided the  member  bank  did  not  accept  to  more  than  50 
per  cent  of  its  capital  and  surplus.^ 

'  For  an  account  of  trade  paper  and  the  usual  character  of  commercial  paper 
before  the  Federal  Reserve  Act,  see  supra.  Chapter  IV,  Sec.  6. 

2  By  act  of  March  3,  1915,  Section  13  was  amended  by  the  addition  of  the 
following  words:  "except  by  authority  of  the  Federal  Reserve  Board,  under 
such  general  regulations  as  said  Board  may  prescribe,  but  not  to  exceed  the 
capital  stock  and  surplus  of  such  bank,  and  such  regulations  shall  apply  to  all 
banks  alike  regardless  of  the  amount  of  capital  stock  and  surplus."  As  a  con- 
sequence, the  board  publishes  lists  of  banks  to  whom  it  is  permitted  to  accept 
up  to  100  per  cent  of  capital  and  surplus,  under  Circular  No.  12,  series  of  1915, 
dated  April  2.  1915  {Bulletin,  May,  1915,  p.  46).  The  restriction  to  100  per 
cent  refers  not  only  to  the  limit  to  which  the  member  bank  may  accept,  but 
also  to  the  limit  of  discounts  of  such  acceptances  by  a  Federal  Reserve  Bank. 

Also,  acceptances  to  any  one  firm  were  hmited  to  10  per  cent  of  capital  and 
surplus,  unless  the  bank  is  secured  either  by  attached  documents  or  by  some 
other  actual  security  growing  out  of  the  same  transaction  as  the  acceptance. 

^  Under  the  act  of  September  7,  1916,  a  Federal  Reserve  Bank  was  permitted 
to  discount  banker's  domestic  acceptances,  provided  shipping  documents  are 


BANKING  PROGRESS 

ikers'  acceptances  were  also  encouraged,  in  the 
I  to  develop  a  discount  market  at  home  and  abroad. 
^^  le  end  of  1915  dealings  in  them  had  risen  to  $100,- 
000,000.  Such  acceptances  were  taken  by  the  Federal 
Reserve  Banks  mainly  by  purchase  in  the  open  market 
(together  with  government  bonds  and  municipal  war- 
rants). In  the  discounts  of  the  Federal  Reserve  Banks, 
however,  bankers'  acceptances  have  not  yet  played  any 
important  part,  rising  only  to  about  $2,000,000  in  one 
month  (November,  1919).  But,  November  30,  1919, 
the  Reserve  Banks  had  purchased  in  the  open  market 
$495,330,000  of  bank  acceptances,  of  which  $347,852,000 
had  been  accepted  by  member  banks. 

The  progress  in  developing  a  discount  market  in  this 
country  through  the  introduction  and  use  of  acceptances 
has  been  very  marked  of  late.  Various  organizations 
have  urged  their  adoption.  Finally  it  has  become  gen- 
erally understood  how  great  an  advantage  it  is  to  change 
dead  trade  accounts  into  live  assets  by  adopting  trade 
acceptances.  The  buyer  of  goods  is  no  worse  off  if, 
instead  of  being  a  debtor  to  the  seller  on  a  book  account, 
he  has  accepted  a  bill  drawn  on  him  for  a  certain  date. 
There  is  the  additional  advantage  for  him  that  he  is 
taught  to  pay  such  debts  when  due  and  not  to  depend 
on  a  running  account  which  is  never  settled. 

It  is  to  be  noted  that  enterprising  State  banks  of  New 
York  began  the  use  of  acceptances  for  financing  exports 
to  Europe  as  early  as  August,  1914.  After  the  inaugura- 
tion, November  16,  1914,  of  the  Federal  Reserve  system, 
national  banks  also  began  accepting  bills.  Since  Feb- 
ruary 12,  1915,  the  Federal  Reserve  Bank  of  New  York 

attached  at  the  time  of  acceptance,  or  which  are  secured  at  the  time  of  accep- 
tance by  a  warehouse  receipt  or  such  other  document  conveying  or  securing 
title  covering  readily  marketable  staples.  See  Regulation  A,  series  of  1917, 
June  22, 1917,  Bulletin,  July,  1917,  p.  540.  For  the  act,  see  Bulletin,  September, 
1916,  pp.  439-442. 


II 


WORKING  OF  FEDERAL  RESERVE  ACT    283 

has  been  buying  acceptances.  Probably  the  most  effec- 
tive measure  for  bringing  about  an  extensive  use  of  ac- 
ceptances was  the  action  of  the  New  York  Clearing- 
House,  August  1,  1918,  ruling  that  notes  and  acceptances 
could  be  sent  through  the  morning  clearings  on  the  day 
of  maturity.  Acceptances  are  thus  treated  as  if  they 
were  checks.^  Finally,  it  has  come  about  that  institu- 
tions have  been  formed  here,  after  the  manner  of  the 
London  Discount  Houses,  for  the  announced  purpose  of 
dealing  in  acceptances  and  foreign  paper.^  The  dis- 
count market  has  practically  arrived. 

Apart  from  discounting  for  member  banks  (Sec.  13), 
the  Reserve  Banks  had  an  important  function  intrusted 
to  them  in  the  power  (Sec.  14)  to  engage  in  open-market 
operations.  Large  and  important  consequences  might 
follow  from  this  power,  especially  as  affecting  market 
rates  of  interest,  and  holdings  of  gold  exchange  or  public 
securities.  The  banks  might  be  able,  in  periods  when 
there  were  few  demands  for  discounts  from  member  banks, 
to  steady  the  rate  of  interest.  Also  the  Reserve  Banks 
could  thus  invest  idle  funds  in  paper  of  various  kinds 
other  than  that  indorsed  by  a  member  bank,  and  in  se- 
curities, which  would  increase  their  earnings  over  and 
beyond  ordinary  discounting.  By  these  operations  pur- 
chases were  made  of  bankers*  acceptances  on  a  consider- 
able scale.  The  regulations  for  the  actual  practice  of 
the  system  were  dated  December  4,  1915.^ 

1  See  Bulletin,  September,  1918,  pp.  819-821.  The  client  should  place  the 
accepting  bank  in  funds  on  the  day  of  maturity  either  by  deposit  of  clearing- 
house funds  one  day  prior  to  maturity;  or  by  cash  or  check  on  the  Federal  Re- 
serve Bank  of  New  York  on  day  of  maturity;  or  by  debit  to  client's  bank  ac- 
count against  funds  cleared  prior  to  such  date. 

^  The  Union  Discount  Corporation  was  directed  to  cotton  acceptances. 
Several  other  houses,  however,  have  been  organized  for  general  acceptance 
operations. 

^  Circular  No.  20,  series  of  1915.  See  also  Special  Instructions,  No.  2,  dated 
^September  15,  1916.    BuLletin,  October,  1916,  pp.  529-534. 


284  BANKING  PROGRESS 

In  regard  to  rates,  it  was  obviously  the  policy  from 
the  beginning  to  establish  low  and  uniform  rates.  There 
was  a  desire  to  have  the  Reserve  Banks  made  serviceable. 
Looking  back,  there  is  a  question  whether  rates  were  not 
fixed  at  a  level  which  tended  to  too  great  expansion  of 
loans,  especially  those  afterward  made  for  carrying  gov- 
ernment obligations.  At  the  close  of  1915  the  rates  on 
bankers'  acceptances  were  little  over  2  per  cent;  trade 
acceptances  about  S}^;  90-day  paper  at  4  and  43/2  5 
commodity  paper ^  at  3  and  33/^.  Such  rates  must  have 
encouraged  rediscounts.  When  we  entered  the  European 
War  in  1917,  however,  a  change  of  importance  took  place. 
Preferential  rates  were  established  in  favor  of  notes  se- 
cured by  government  certificates  or  bonds.-  As  low  as 
3  per  cent  was  granted  for  15-day  paper  of  this  sort; 
and  in  general  it  was  intended  that  the  rate  should  corre- 
spond with  the  rate  paid  by  the  bonds.  Such  a  policy 
may  have  been  justified  by  the  necessity  of  selling  bonds; 
but,  whatever  the  reason,  it  was  a  great  departure  from 
the  fundamental  principles  of  the  Federal  Reserve  Act. 
It  favored,  instead  of  discriminated  against,  loans  based 
on  securities  as  collateral.  That  an  enormous  change 
should  take  place  in  the  character  of  the  liquid  holdings 
of  the  system  was  certain.  Consequently,  it  was  inevi- 
table that  difficulties  should  arise,  and  that  at  the  end 
of  1919  the  rate  on  loans  secured  by  war  obligations  should 
be  raised  to  5}/2  per  cent  in  order  to  force  their  liquida- 
tion, no  matter  how  painful  the  process  might  be.  It 
is  a  question  whether  the  rates  should  not  have  been 
raised  on  this  kind  of  paper  long  before.  The  rise  in  the 
rate  of  discount  should  be  used  as  a  preventive  rather 

'  Commodity  rates  were  designed  to  appeal  to  the  growers  of  cotton  and 
grain.  December  3,  1917,  this  kind  of  paper  was  merged  with  other  com- 
mercial paper.    Annual  Report,  1917,  pp.  11,  103. 

2  See  Bulletin,  June,  1917,  p.  425. 


WORKING  OF  FEDERAL  RESERVE  ACT    285 

than  as  a  cure.  In  December,  1917,  while  rates  in  gen- 
eral were  raised,  a  preferential  rate  was  still  given  to  war 
paper. 

One  form  of  paper,  however,  was  anomalous  and  had 
no  place  in  the  system.  The  treatment  of  farm  paper 
was  governed  more  by  political  than  by  legitimate  bank- 
ing considerations.  In  the  original  act  (Sec.  13)  agricul- 
tural paper,  having  a  maturity  not  exceeding  six  months, 
was  comprised  in  the  provisions  maintaining  the  funda- 
mental liquidity  of  paper  to  be  discounted  by  a  Reserve 
Bank.^  An  inconsistent  provision,  however,  was  wrongly 
introduced  in  Sec.  24,  allowing  country  banks  to  loan 
on  farm  lands  for  five  years  to  50  per  cent  of  the  value 
of  the  land;  but  such  loans  were  limited  to  25  per  cent 
of  the  bank's  capital  and  surplus,  or  to  one-third  of  its 
time-deposits. 2  This  was  contrary  to  the  spirit  of  the 
act.  Such  loans  should  have  been  made  only  by  banks 
such  as  were  later  organized  separately  under  the  Federal 
Land  Bank  Act.^  But  an  amendment  to  the  Federal 
Reserve  Act,  September  7,  1916,  went  further  in  the 
wrong  direction  by  admitting  loans  on  real  estate  as 
distinguished  from  those  on  farm  land. 

§  2.  The  original  act  required  that  the  capital  should 
be  paid  in  gold,  but  that  the  reserves  might  be  paid  in 
lawful  money,  or  even  that  one-half  might  be  in  the  form 
of  rediscounted  paper.  It  was  also  understood  that 
banks  might  draw  on  their  city  correspondents  for  funds 
for  this  purpose.     Before  the  opening  of  the  system, 

^  Rediscounts  of  six  months'  paper  were  limited  to  198  per  cent  of  the  sub- 
scribed capital  of  a  Reserve  Bank.  Bulletin,  September,  1916,  p.  443,  and  Regul. 
G,  Fourth  Annual  Report,  p.  175. 

2  Regulation  I,  series  of  1915,  Bulletin,  Maj%  1915,  p.  43.  Cf.  Annual 
Report,  1916,  p.  163. 

'  Enacted  July,  1916,  and  organized  March,  1917. 


286 


BANKING  PROGRESS 


however,  the  Reserve  Board  ^  urged  each  bank  to  make 
payment  in  its  own  gold  and  from  its  own  vaults.  Since 
reserves  could  be  had  by  rediscounting  paper,  there  was 
no  reason  for  member  banks  to  hoard  gold.  The  result 
appeared  in  the  first  published  account,  which  is  interest- 
ing for  comparison  with  recent  expanded  accounts: 


Nov.  20,  1914 


[In  millions] 


Liabilities 

Assets 

Capital 

Deposits 

Federal  Reserve  notes . . . 

...$  18.1 

...  2Se7.8 

1.2 

Loans $    5.6 

Investments ... 

Other  resources .1 

Gold $204.9 

Lawful  money 36 . 5 

Total  cash 241.4 

$247.1 

$247.1 

The  reduction  in  the  reserves  to  be  carried  by  member 
banks  under  the  new  act  (Sec.  19)  came  when  the  old 
national  banks  were  below  the  legal  reserv^es  in  the  panic 
of  1914.  There  was,  therefore,  a  very  considerable  re- 
lease of  reserves,  and  an  easement  of  the  market  rate, 
when  the  new  system  went  into  operation.  The  act  set 
a  transition  period  of  three  years,  ending  November  16, 
1917,  within  which  reserves  were  to  be  partly  withdrawn 
from  the  vaults  of  member  banks  and  gradually  placed 
with  the  Reserve  Banks.  At  the  end  of  this  period  about 
one-third  of  the  required  reserves  were  to  remain  in  the 
vaults  of  country  and  reserve  city  banks.  There  was  a 
fear  of  disturbance  during  the  process.  In  the  act  of 
August  15,  1914,  some  slight  changes  were  made  in  the 
fractions  to  be  held  at  home  and  in  the  Reserve  Banks.^ 

1  Circular  No.  10.  October  28,  1914.    First  Annual  Report,  p.  167. 

-  Also  a  State  bank,  becoming  a  member,  might  for  a  time,  under  certain 
conditions,  keep  its  reserves  with  a  non-member  bank.  But  no  member  bank 
should,  without  consent,  obtain  discounts  from  a  Reserve  Bank  for  a  non- 
member  bank.    See  First  Annual  Report,  p.  45. 


WORKING  OF  FEDERAL  RESERVE  ACT    287 

By  November  26,  1915,  member  banks  had  without  dif- 
ficulty paid  into  the  Reserve  Banks  $321,068,000  of  gold. 
The  State  banks  showed  Httle  disposition  to  join  the 
new  system,  and  several  States  lowered  the  legal  reserves 
for  their  banks.  In  such  eases  the  general  reserve  system 
was  weakened  to  allow  State  banks  to  compete  with 
member  banks  now  supported  by  the  ability  to  gain  re- 
serves at  any  moment  by  rediscounts.  In  the  act  of 
September  7,  1916,  member  banks  were  permitted  to 
carry  in  Reserve  Banks  any  reserves  then  required  to  be 
kept  in  their  own  vaults.  At  the  same  time  efforts  were 
made,  in  1916,  to  hasten  the  final  movement  of  reserves 
to  the  Reserve  Banks  and  not  to  wait  until  November 
16,  1917.  Because  of  the  abnormal  imports  of  gold  due 
to  excessively  large  war  exports,  it  was  believed  the 
member  banks  could  advance  their  payments  of  reserves 
and  also  strengthen  the  gold  holdings  of  the  Reserve 
Banks.  The  act  of  June  21,  1917  (Sec.  10),  finally  car- 
ried this  policy  into  effect,  and  at  the  same  time  lowered 
the  percentage  of  reserves.  Section  19  of  the  Federal 
Reserve  Act  was  so  amended  ^  as  to  provide  for  the  im- 
mediate transfer  of  all  reserves  to  the  Federal  Reserve 
Banks;  and  the  amounts  of  required  reserve  were  fixed 
as  follows: 


Demand- 
deposits 
Per  cent 


Time- 
deposits 
Per  cent 


Country  banks 

Reserve  city  banks^ 

Central  reserve  city  banks 


7 
10 
13 


Thereafter  member  banks  were  not  required  to  carry 
any  reserves  in  their  own  vaults;    but  the  new  amend- 

*  See  Federal  Reserve  Bulletin,  July,  1917,  pp.  508,  517.     The  weekly  state- 
ment of  June  23,  1917,  appears  in  the  revised  form. 

*  For  the  revised  list  of  reserve  cities,  see  Annual  Report,  1917,  p.  30. 


288  BANKING  PROGRESS 

ments  had  the  effect  of  obliging  the  banks  to  increase 
their  former  holdings  with  the  Reserve  Banks. 

To  this  point  we  have  been  concerned  with  reserves 
kept  for  deposits.  But  we  are  already  confronted  with 
a  shortcoming  in  the  Federal  Reserve  system  through 
the  confusion  of  notes  and  deposits.  The  two  are  un- 
scientifically mixed  together.  The  reserves  in  gold  be- 
hind the  notes  ought  to  be  kept  distinct  from  any  regula- 
tions for  reserves  behind  the  deposits.  In  practice,  it 
was  desired  to  ^ncourage  the  deposit  of  gold  for  reserve 
notes  even  to  100  per  cent,  so  that  they  would  serve  the 
same  purpose  as  gold  certificates.  Unfortunately  the 
act  is  structurally  weak  at  this  point.  Since  only  40 
per  cent  in  gold  is  required  behind  the  notes,  the  addi- 
tional gold  could  be  transferred  to  reserves  behind  de- 
posits, in  exchange  for  commercial  paper.  Thus  prac- 
tically a  new  basis  for  reserves  in  gold  was  established 
in  June,  1917.^  As  time  went  on  and  the  system  was 
strained  in  the  effort  to  carry  enormous  loans  based  on 
war  and  other  obligations,  the  consequent  rise  of  the  de- 
posit item  due  to  discounts  directly  affected  the  percent- 
age of  reserves  behind  both  notes  and  deposits.  But 
the  ratio  computed  on  both  notes  and  deposits  was  con- 
fusing and  gave  no  true  understanding  of  the  situation. 

§  3.  There  had  always  existed  some  antipathy  be- 
tween national  banks  and  those  chartered  by  the  States. 
Yet  from  the  passage  of  the  Federal  Reserve  Act  it  was 
the  evident  purpose  to  unify  all  the  banks  of  the  country. 
State  requirements  had  been  less  severe  regarding  re- 
serves, examinations,  etc.;  and  State  banks  had  been 
granted  many  auxiliary  privileges — low  reserves  against 
savings-accounts,  powers  to  act  as  executor,  trustee,  ad- 

1  See  Bulletin,  July,  1917,  pp.  503-504. 


I 


WORKING  OF  FEDERAL  RESERVE  ACT    289 

ministrator,  registrar,  etc.,  not  permitted  to  national 
banks — at  the  same  time  that  they  carried  on  the  bank- 
ing functions  of  deposit  and  discount.  Thus  large  banks 
had  grown  up  outside  the  national  banking  system. 
From  the  start,  overtures  were  made  to  State  banks  to 
join  the  new  system,  but  to  little  avail.  Of  course,  a 
State  bank  on  entering  must  conform  to  requirements 
estabUshed  for  all  member  banks;  but  the  laws  of  some 
States  afforded  difficulties.  There  was  strenuous  ob- 
jection by  the  smaller  banks  to  the  loss  on  collections 
involved  in  going  into  the  new  system  with  its  clearings 
at  par;  but  also  to  new  examinations  and  intricate  state- 
ments as  well  as  to  the  loss  of  interest  on  balances,  if 
reserves  were  to  be  transferred  to  the  Reserve  Banks. 

In  the  main,  State  banks  and  trust  companies  had 
grown  up  in  competition  with  the  national  banks,  until 
they  were  far  greater  in  number,  because  of  forms  of 
business  not  allowed  to  national  banks.  If,  therefore, 
it  were  to  be  made  easy  for  State  banks  to  become  mem- 
bers, it  was  obvious  that  national  banks  should  not  be 
cut  off  from  those  forms  of  business  formerly  confined  to 
State  banks.  This  was  granted  in  the  original  act,^  but 
later  (September  26,  1918)  guarded  by  requiring  separate 
accounts  for  trust  funds  and  the  like.  Nevertheless, 
these  provisions  were  regarded  as  an  intrusion  into  the 
private  preserves  of  State  banks;  and  their  constitu- 
tionality was  even  denied.^ 

The  dealings  of  directors  and  attorneys  with  a  bank 
in  Section  22  of  the  original  act  caused  difficulty.  In 
order  to  prevent  illegitimate  operations  by  which  officials 

^  Sec.  9  (K).  To  grant  by  special  permit  to  national  banks  applying  therefor, 
when  not  in  contravention  of  State  or  local  law,  the  right  to  act  as  trustee, 
executor,  administrator,  or  registrar  of  stocks  and  bonds  under  such  rules  and 
regulations  as  the  said  board  may  prescribe. 

'  See  Annual  Report,  1915,  p,  12. 


290  BANKING  PROGRESS 

could  make  a  profit  in  bringing  business  to  the  bank,  the 
act  had  practically  prohibited  directors  from  doing  busi- 
ness with  the  bank.*  The  act  of  September  26,  1918, 
while  providing  against  improper  transactions,  permitted 
dealings  in  the  regular  course  of  business  between  a 
member  bank  and  its  directors,  or  a  firm  to  which  they 
belonged,  with  certain  publicity  of  details. 

It  soon  became  clear  that  State  banks  could  earn 
more^  by  joining  the  new  system  and  transferring  reserves 
to  Reserve  Banks,  because  a  large  part  of  them  could  be 
invested  in  a  form  which  would  serve  as  safe  secondary 
reserves.  Moreover,  Section  9  was  so  amended  by  the 
act  of  June  21,  1917,  as  to  allow  a  State  bank  or  trust 
company  to  retain  its  full  charter  and  statutory  rights, 
with  all  corporate  powers  granted  it  by  the  State,  and 
yet  become  a  member  of  the  new  system.^  Changes  in 
State  laws  also  removed  obstacles.  Finally,  all  objections 
seem  to  have  been  removed.  Even  then  many  State 
banks  remained  out.  No  marked  change,  however,  ap- 
peared until  the  necessities  of  the  war  brought  the 
stimulus  sufficient  to  cause  a  general  movement  into 
the  new  system.  The  appeal  of  President  Wilson,  Oc- 
tober 13,  1917,  for  a  complete  mobilization  of  the  bank- 
ing and  credit  resources  of  the  United  States,  because 
of  our  entry  into  the  European  War,  was  met  by 
a   patriotic   response   from   State   banks.*    The  largest 

1  See  Bulktin,  June,  1918,  pp.  513-515. 

*  See  Bulletin,  July,  1918,  pp.  615-622. 

^  It  was  not  subject  to  examination  by  the  comptroller.  Also  examinations 
by  State  authorities  might  be  accepted,  if  approved  by  the  Federal  Reserve 
Board.  See  Bulletin,  July,  1917,  p.  512.  It  could  withdraw  on  six  months' 
notice,  and  was  imaffected  by  Sec.  8  of  the  Clayton  Act,  relating  to  interlock- 
ing directorates. 

*  Yet  as  late  as  June,  1918,  there  were  about  8,000  eligible  State  institutions 
with  a  capital  of  about  $695,000,000  and  surplus  of  $425,000,000  out  of  the 
system.  At  the  end  of  1919  there  were  1,181,  with  capital  of  $421,000,000  and 
surplus  of  $447,000,000  in  the  system. 


WORKING  OF  FEDERAL  RESERVE  ACT    291 

State  banks  are  as  a  rule  now  in  the  Federal  Reserve 
system. 

§  4.  The  obvious  intent  of  the  Federal  Reserve  Act 
(Sections  13,  16)  to  take  over  the  clearing  of  checks 
raised  a  question  of  serious  difficulty,  not  only  because 
it  warred  against  established  customs  but  against  the 
close  relations  of  banks  with  their  city  correspondents. 
Moreover,  the  system  could  control  only  member  banks. 
The  stumbling-block  lay  in  the  matter  of  charges  for 
collection  and  exchange.  In  the  past  the  reserves  kept 
with  correspondents  had  been  drawn  upon  for  exchange, 
and  banks  had  made  a  charge  for  collection. 

March  4,  1915,  the  Reserve  Board  provided  for  the 
voluntary  clearing  of  checks  within  each  district.^  It 
did  not  supersede  existing  local  clearing-houses,  nor  did 
it  cover  the  clearing  of  checks  between  banks  in  different 
districts,  nor  the  settlement  of  balances  between  Federal 
Reserve  Banks.  Meanwhile,  October  4,  1915,  checks 
on  the  Richmond  Reserve  Bank  were  by  arrangement 
received  at  par  by  the  New  York  Reserve  Bank.  Early 
in  December,  1914,  the  St.  Louis  and  Kansas  City  Re- 
serve Banks  had  permission  to  apply  a  required  system 
to  their  members;  but,  when  the  voluntary  system  was 
later  introduced,  80  per  cent  of  the  St.  Louis  district  and 
all  of  the  Kansas  City  district  continued  their  member- 
ship. The  loss  of  exchange  business  and  the  opposition 
to  having  a  check  which  a  bank  had  not  seen  charged 
against  its  account  at  a  Reserve  Bank  worked  against 
the  success  of  the  plan. 

In  April,  1916,  a  more  comprehensive  plan  was  elabo- 
rated to  go  into  effect  July  15,  1916.  Each  Reserve  Bank 
was  required  to  exercise  the  functions  of  a  clearing-house 

^  See  Bulletin,  May,  1915,  p.  6,  and  June,  1915,  p.  78. 


292  BANKING  PROGRESS 

for  its  members  on  interdistrict  checks.  No  member 
bank  was  required  to  use  it;  and  members  could  still  keep 
accounts  with  correspondents;  but  they  must  pay  at  par 
all  checks  drawn  on  them  and  presented  at  their  own  coun- 
ters. Federal  Banks  presented  checks  by  mail,  but  did 
not  debit  items  until  returns  came  back  from  each  bank.^ 
Checks  on  State  banks  that  could  be  collected  at  par 
were  received.  Subject  to  a  small  service  charge  (not 
over  2  cents  per  item)  par  collections  by  the  end  of 
1916  extended  to  over  15,000  banks.  It  was  an  advan- 
tage to  a  bank  as  against  a  competitor  that  its  checks 
were  receivable  at  par.  On  July  15,  1916,  the  Federal 
Reserve  Bank  of  Boston  took  over  the  work  of  the  Boston 
Clearing-House,  and  collected  checks  on  all  banks  (in- 
cluding State  banks)  in  its  district  without  charge  (ex- 
cept a  service  charge  of  0.9  cent  per  item). 

The  act  of  September  7,  1916,  and  of  June  21,  1917, 
amended  Section  13  of  the  Federal  Reserve  Act,  in  order 
to  extend  clearings  to  those  non-member  banks  which 
maintain  with  a  Reserve  Bank  a  balance  sufficient  to 
cover  items  presented  for  exchange  or  collection.  Mem- 
ber banks  were  allowed  to  charge  for  collection,  but  not 
over  10  cents  per  $100;  but  no  charge  could  be  made 
against  a  Reserve  Bank.^ 

When  reserves  were  no  longer  (after  June  21,  1917) 
held  in  other  banks  nor  in  a  bank's  vaults,  there  was  no 
reason  why  exchange  should  not  be  drawn  on  Reserve 
Banks,  nor  was  there  anything  to  restrict  clearings  by 
member  banks  through  the  new  system  except  the  matter 

» See  Bulletin,  June,  1916,  p.  262;  July,  1916,  p.  312.  Regulation  J,  series 
of  1916  (Bulletin,  October,  1916,  p.  542),  superseded  former  ones. 

'  An  opinion  was  rendered  by  Attorney-General  Gregory,  March  21,  1918, 
excluding  non-member  banks  from  limitations  as  to  charges.  See  Bulletin, 
May,  1918,  pp.  367-371.  See  also  Annual  Report,  1917,  p.  23,  on  the  Hard- 
wick  Amendment. 


WORKING  OF  FEDERAL  RESERVE  ACT    293 

of  charges  for  the  expense  incurred.  Country  banks  had 
been  accustomed  to  make  a  charge  for  exchange  in  re- 
mitting for  checks  drawn  on  themselves,  but  by  the  new 
system  they  must  remit  at  par.  The  power  to  fix  charges 
remains  in  the  hands  of  the  Federal  Reserve  Board, 
but  there  has  been  much  opposition  to  the  compensation 
granted.^  Great  efforts,  nevertheless,  have  been  made 
to  have  all  the  banks  in  a  State  join  the  par  list.  At  the 
end  of  1919  there  was  a  daily  average  of  clearings  of  over 
$600,000,000  by  9,055  member  banks  and  15,851  non- 
member  banks  on  the  par  list.^  But  as  yet  the  system 
is  not  universal. 

A  system  of  transfer  drafts  also  has  been  inaugurated, 
by  which  a  draft  of  a  member  bank  on  its  Reserve  Bank 
may  be  paid  without  time  allowance  or  deduction  at  any 
other  Reserve  Bank,  Such  a  method  requires  the  exist- 
ence of  the  Gold  Settlement  Fund  at  Washington  as  a 
means  of  clearing  between  the  twelve  Reserve  Banks. 
This  fund  was  established  as  early  as  May  27,  1915.^  By 
this  means  the  title  to  funds  in  one  district  can  be  trans- 
ferred to  another  without  the  actual  movement  of  money. 
Each  Reserve  Bank  is  required  to  keep  in  this  fund  with 
the  Treasury  of  the  United  States  a  balance  of  not  less 
than  $1,000,000.  Reports  are  made  on  each  Wednesday 
evening  by  telegraph  for  the  "checker-board, "  and  weekly 
statements  are  issued.  The  first  withdrawal  was  made 
July  14,  1915,  by  a  telegram  from  the  Federal  Reserve 
Bank  of  Chicago,  filed  at  10.30  a.  m.,  and  at  2.30  p.  m. 

>  See  the  Report  of  the  "Committee  of  Five"  of  the  American  Bankers* 
Association,  Bulletin,  October,  1918,  p.  962.  Cf.  Bulletin,  May,  1918,  p.  371; 
September,  1918,  p.  819. 

^  Bulletin,  January,  1920,  p.  94.  The  map  showed  the  Southern  States  as  a 
whole  not  on  the  par  list.  Cf.  Bulletin,  December,  1919,  pp.  1113-1114.  For 
meaning  of  "par,"  see  Bulletin,  July,  1916,  p.  310. 

'  Regulation  L,  series  1915,  Bulletin,  June,  1915,  p.  78.  Second  Annual  Re- 
port, pp.  77-79. 


294  BANKING  PROGRESS 

of  the  same  day  the  assistant  treasurer  of  the  United 
States  at  Chicago  was  ready  to  make  payment  to  the 
Chicago  Bank  of  the  $2,000,000  requested.^  In  Sep- 
tember, 1915,  transfers  in  the  Gold  Settlement  Fund 
were  authorized  between  each  federal  reserve  agent  and 
Federal  Reserve  Banks. ^  The  Federal  Reserve  Agents' 
Fund  consisted  of  gold  deposited  for  safe-keeping  with  the 
Federal  Reserve  Board  and  held  by  them  to  reduce  the 
habUity  of  Reserve  Banks  against  Federal  Reserve  notes 
outstanding.  At  first,  gold  order-certificates  on  the 
treasurer  in  denominations  of  $10,000  were  used,  but 
have  been  discontinued.  The  total  volume  of  clearings 
through  this  fund  during  1918  amounted  to  $26,962,- 
946,500,  the  large  figure  being  chiefly  due  to  sales  of  gov- 
ernment obligations.  But  the  transfers  also  prevented 
the  old  shifting  of  funds  for  crop-moving  purposes. 

The  success  of  the  Gold  Settlement  Fund  in  saving 
shipments  of  gold  within  one  large  country  has  suggested 
the  possibility  of  an  international  gold  exchange  fund  for 
commercial  transactions  between  nations.  It  seems  clear, 
however,  that  the  depreciation  of  European  money  will 
for  many  years  postpone  any  such  plan.^ 

§  5.  The  Federal  Reserve  system  began  operations 
in  1914  when  we  owed  a  large  sum  of  gold  to  Europe. 
Our  phenomenal  exports  of  goods,  however,  from  1915 
entirely  reversed  the  movement  of  gold.  As  a  consequence 
our  banking  and  currency  system,  by  an  unequalled  stroke 
of  good  fortune,  and  in  spite  of  the  expansion  due  to  the 
war,  has  been  throughout  maintained  on  a  basis  of  un- 
equivocal convertibility  into  gold.     The  exceptional  im- 

1  Bulletin,  August,  1915,  p.  183. 
-  Bulletin,  October,  1915.  p.  303. 

^  See  Fifth  Annual  Report,  p.  35.    As  concerns  South  America  and  the  western 
hemisphere,  see  Bulletin,  March,  1919,  p.  198. 


II 


WORKING  OF  FEDERAL  RESERVE  ACT    295 

ports  of  gold  and  the  concentration  of  reserves  brought 
about  by  the  new  banking  system  united  to  raise  the 
gold  reserves  of  the  Reserve  Banks  at  the  close  of  1919 
to  $2,078.4  milhons.  It  is  estimated  that  $300,000,000 
of  hoarded  gold  have  been  returned  to  the  banks  since 
the  armistice.^  To  prevent  gold  escaping  to  enemy 
countries,  since  September  7,  1917,  an  embargo  was  placed 
on  the  exportation  of  gold.^  The  original  act  did  not  pro- 
vide for  the  direct  issue  of  Federal  Reserve  notes  against 
gold  deposited  with  Reserve  Banks.  For  a  time  the  Re- 
serve Banks  deposited  surplus  gold  with  reserve  agents, 
and,  by  withdrawing  the  pledged  paper,  thereby  reduced 
their  liability  for  notes  outstanding.  Thus  at  the  close 
of  1916,  of  $300,110,000  notes,  only  $17,588,000  were  se- 
cured by  commercial  paper.  But  by  the  act  of  June  21, 
1917,  it  was  proposed  to  make  the  note  function  as  a  gold 
certificate.  Unfortunately  a  40  per  cent  reserve  of  gold 
does  not  make  a  gold  certificate.'  As  we  shall  see  later 
this  was  a  means  of  unduly  expanding  credit,  because  the 
excess  gold  was  transferred  to  reserves  for  deposits.  At 
the  time,  however,  it  served  to  augment  the  gold  holdings 
of  the  Reserve  Banks. 

With  over  $2,000,000,000  in  gold,''  with  an  amazing 
excess  of  exports  of  goods,  a  creditor  to  other  nations, 
thereby  possessing  the  claim  through  the  foreign  ex- 
changes over  funds  in  other  countries,  the  position  of 
the  United  States  was  almost  incredibly  strong  as  re- 
gards the  gold  basis.  It  is  now  the  only  country  which 
can  offer  a  free  market  for  gold.    And  yet  in  spite  of  such 

1  Bulletin,  July,  1919,  p.  616. 

'  Removed  June  26,  1919,  with  a  few  exceptions  affecting  Russia.  See  Bvl- 
letin,  September,  1919,  p.  853. 

'  The  jubilation  on  this  matter  {Fourth  Annual  Report,  p.  12)  is  scarcely  jus- 
tified. 

*  Exclusive  of  gold  in  the  Treasury  and  national  banks.  For  the  gold  reserves 
of  the  world,  see  Bulletin,  February,  1919,  p.  140. 


296  BANKING  PROGRESS 

good  fortune  we  have  a  situation  in  1920  in  which  we 
have  actually  reached  the  Hmit  of  our  banking  credit, 
due  to  loans  based  on  unliquid  war  obligations,  and  to 
the  pressure  for  loans  in  other  directions. 

§  6.  In  foreign  operations  the  original  act  (Section  14) 
allowed  Reserve  Banks  to  establish  foreign  agencies,  to  deal 
in  cable  transfers  and  eligible  paper  with  foreign  banks; 
and  also  (Section  25)  permitted  our  national  banks, 
having  a  capital  and  surplus  of  $1,000,000,  to  establish 
branches  in  foreign  countries.  The  limitations  of  these 
provisions  led  to  demands  for  more  latitude.  The  secre- 
tary of  the  treasury  opposed  the  creation  of  independent 
foreign  banks,  and  urged  the  entrance  of  the  Federal 
Reserve  Banks  into  Latin  America  through  joint  agencies; 
but  the  board  was  adverse  to  locking  up  its  reserve  funds 
in  loans  of  the  character  available  in  those  countries.^ 
The  act  of  September  7,  1916,  then  permitted  a  bank  to 
subscribe  not  exceeding  10  per  cent  of  its  capital  and 
surplus  to  the  stock  of  banks  chartered  in  the  United 
States  to  carry  on  foreign  banking  under  some  regulation 
by  the  Federal  Reserve  Board.-  Finally,  greater  freedom 
was  allowed  by  the  Edge  Act^  of  December  24,  1919,  by 
which  federal  corporations,  under  the  approval  of  the 
Federal  Reserve  Board,  were  authorized  in  foreign  deal- 
ings to  carry  on  the  functions  of  discount  and  deposit, 
and  even  to  issue  notes.  They  may  also  be  asked  to  serve 
as  fiscal  agencies  for  the  Treasury. 

Under  Section  14  the  Federal  Reserve  Bank  of  New 

» See  Bulletin,  October,  1915,  p.  313,  and  November,  1915,  p.  348. 

'  At  the  end  of  1918  the  National  City  Bank  of  New  York  had  established 
more  than  a  score  of  foreign  branches,  and  the  First  National  Bank  of  Boston 
one  in  Buenos  Aires.  See  Bulletin,  October,  1918,  p.  942,  and  November,  1918, 
p.  1079.  In  addition  five  banking  corporations  had  qualified.  Fifth  Annual 
Report,  p.  59.    For  list  at  end  of  1919,  see  Bulletin,  December,  1919,  p.  1154. 

» See  Bulletin,  January,  1920,  pp.  56-59. 


a 


WORKING  OF  FEDERAL  RESERVE  ACT    297 

York  was  authorized,  December  25,  1916,  to  appoint  as 
its  foreign  agent  the  Bank  of  England.  Accordingly, 
)  June  7,  1917,  obligations  in  London  amounting  to  $50,- 
000,000,  due  to  Americans,  were  paid  to  the  Bank  of 
England.  The  Reserve  Bank  of  New  York  assumed  the 
obligation  to  American  holders  of  the  paper  (properly 
distributed  to  other  Reserve  Banks),  but  the  gold,  "ear- 
marked" by  the  Bank  of  England,  became  a  part  of  the 
reserves  of  our  Reserve  Banks  under  the  item  *'Gold 
held   with   foreign   agencies."      Likewise,    February    28, 

1917,  the  Reserve  Bank  of  New  York  established  an 
agency  with  the  Banque  de  France  at  Paris. ^    In  June, 

1918,  foreign  exchange  with  Italy  was  made  subject  to 
the  approval  of  the  representative  of  the  Italian  Institute 
of  Exchange.^ 

§  7.  No  other  event  can  compare  in  importance  and 
in  its  effect  on  the  Federal  Reserve  system  with  the 
European  War.  Not  only  did  it  touch  every  function 
of  banking,  but — most  significant  of  all — it  put  to  the 
test  and  brought  out  all  structural  weakness.  In  Europe 
the  tremendous  strain  on  banking  systems  showed  the 
inferior  quality  of  the  French  and  German  to  the  English.^ 
Yet  in  the  United  States,  in  the  matter  of  placing  gov- 
ernment loans,  we  tended  to  follow  Continental  rather 
than  English  experience  as  regards  borrowing  directly 
from  the  banks.  In  Great  Britain  and  in  the  United 
States  alone  is  there  the  same  method  of  using  checks 
drawn  on  deposits  as  a  means  of  payment,  instead  of 
using  bank-notes  as  on  the  Continent.  And  yet  we 
tended  away  from  the  very  genius  of  English  and  Ameri- 

*  See  Bulletin,  January,  1917,  p.  5,  and  March,  1917,  p.  175. 

2  Bulletin,  July,  1918,  p.  594. 

•'  See  Laughlin,  Credit  of  the  Nations,  chaps.  Ill,  IV,  and  V. 


298  BANKING  PROGRESS 

can  practice  in  being  led  to  depend  largely  upon  issues 
of  notes.  This  tendency  has  been  seen  in  preceding 
chapters.  In  the  war  our  banking  policy  was  dominated 
by  a  political  rather  than  by  a  banking  intelligence. 

In  Great  Britain  the  Bank  of  England  is  used  strictly 
as  a  fiscal  agent  to  whom  revenues  are  paid  and  by  whom 
expenditures  are  met.  The  bank  does  not  itself  sub- 
scribe to  great  loans;  it  acts  as  an  agent  only,  except  so 
far  as  the  Treasury  secures  aid  by  ways  and  means  credits 
at  the  bank.  On  November  23,  1915,  the  secretary  of 
the  treasury  (under  the  permissive  authority  in  Section 
15  of  the  act)  appointed  the  Federal  Reserve  Banks  as 
depositaries  and  fiscal  agents  of  the  United  States,^  to 
take  effect  January  1,  1916.  On  that  date  government 
funds  m  national  banks  were  transferred  to  the  Reserve 
Banks. 2  But,  after  we  entered  the  war,  on  the  offer  of 
the  First  Liberty  Loan,  the  Reserve  Banks  were  desig- 
nated. May  14,  1917,  as  fiscal  agents  on  loan  subscrip- 
tions. This  was  the  beginning  of  operations  that  in- 
volved the  banks  in  very  large  transactions. 

In  anticipation  of  the  bond-issue,  short-term  certifi- 
cates of  indebtedness  were  offered  to  the  banks  and  the 
pubhc.  The  proceeds  from  the  latter,  turned  over  to 
the  Reserve  Banks  for  the  government  account,  were 
at  once  paid  out  by  the  Treasury  for  war  supplies,  or 
to  the  Allies,  who  spent  the  sums  in  this  country.  These 
expenditures  immediately  returned  to  the  banks  as  pri- 
vate deposits.  Thus  funds  subscribed  to  the  Treasury 
came  back  before  the  bond-issue  was  offered,  and  pre- 
vented a  convergence  of  payments  on  any  fixed  date. 
When  the  long-term  bonds  later  appeared  for  subscrip- 

» See  Bulletin,  December,  1915,  p.  395. 

^  Already  $15,000,000  had  been  transferred  to  the  Reserve  Banks  of  Rich- 
mond, Atlanta,  and  Dallas  ($14,000,000  through  the  Gold  Settlement  Fund) 
to  aid  in  the  movement  of  cotton. 


WORKING  OF  FEDERAL  RESERVE  ACT    299 

tion,  the  volume  of  outstanding  certificates,  which  were 
exchangeable  for  bonds  at  par,  were  used  in  payment 
of  the  bonds  chiefly  by  the  banks;  or  as  the  government 
paid  off  the  certificates  the  proceeds  were  given  for  bonds. 
Customers  of  banks,  subscribing  for  bonds,  would  pay 
either  by  cash,  by  checks  drawn  on  their  deposit-accounts, 
or  by  the  proceeds  from  loans  got  from  the  banks  secured 
by  the  bonds  as  collateral.  When  member  banks  remitted 
to  Federal  Reserve  Banks  for  bonds  taken,  they  drew 
down  their  cash  assets,  or  their  reserves  in  the  Federal 
Reserve  Banks.  But  these  reserves  could  be  replenished 
by  a  rediscount  of  customer's  paper  secured  by  war  ob- 
ligations (departing  thus  from  commercial  paper,  as  re- 
quired by  the  true  principle  of  the  act)  at  the  Federal 
Reserve  Bank,  or  by  the  direct  15-day  note  of  member 
banks  supported  by  bonds  or  certificates.^  The  outcome 
of  this  credit  operation — while  not  necessarily  increasing 
the  demand  of  the  public  for  more  notes  as  a  medium  of 
exchange — was  the  existence  of  a  large  amount  of  gov- 
ernment obligations  in  the  assets  of  the  banking  system 
to  protect  demand-liabilities  of  the  banks  either  in  the 
form  of  deposits  or  notes.  At  the  end  of  1919  the  total 
of  these  undigested  securities  rediscounted  at  the  Re- 
serve Banks  amounted  to  $1,510,364,000.2  Thus  the 
banks  themselves  became  deeply  involved  in  the  fiscal 
operations  of  the  government.  In  passing  from  com- 
mercial paper  to  war  obligations  as  a  basis  for  rediscount 
the  way  was  opened  for  an  extension  of  credit  limited 

^  This  policy  was  encouraged  by  a  preferential  rate  on  such  loans,  as  well  as 
on  those  to  customers  of  banks.  Member  banks  were  also  allowed  to  redis- 
count thus  for  non-member  banks.  Bulktin,  Jime,  1917,  pp.  425-426.  Banks 
and  trust  companies  subscribing  to  more  than  $100,000  bonds  were  considered 
as  depositaries,  and  could  pay  by  granting  a  credit  on  their  books  to  the  Trea- 
sury.    See  also  Fifth  Annual  Report,  p.  79,  for  the  act  of  April  4,  1918. 

2  The  war  paper  held  by  all  banks  was  $2,495,000,000.  Bulletin,  October, 
1919,  p.  943. 


300  BANKING  PROGRESS 

only  by  the  needs  of  the  Treasury.  It  is  not  forgotten, 
of  course,  that  the  original  act  (Sec.  14)  permitted  the 
rediscount  of  paper  based  on  bonds  and  notes  of  the  United 
States;  but  the  context  shows  it  could  never  have  con- 
templated the  use  of  such  paper  on  the  great  scale  ac- 
tually permitted  during  the  war.  Also  the  banks  came 
to  own  very  large  amounts  of  bonds  as  investments.  Here 
was  a  great  danger;  for  as  one  vast  loan  followed  after 
another,  the  mass  of  unliquid  securities  was  enormously 
increased,  since  the  bonds  were  salable  only  at  prices 
steadily  declining  below  par.  In  such  ways  our  prac- 
tice differed  from  that  of  the  Bank  of  England. 

A  measure,  having  a  tendency  to  expand  credit  on 
collateral  not  acceptable  to  a  Reserve  Bank,  was  enacted 
April  5,  1918,  by  which  the  War  Finance  Corporation^ 
was  created  with  a  capital  of  $500,000,000  provided  by 
the  government.  The  Federal  Reserve  Banks  were  for- 
bidden to  discount  paper  supported  by  stocks  or  bonds, 
although,  as  we  have  just  seen,  this  policy  (not  the  law) 
was  departed  from  in  making  loans  based  on  our  govern- 
ment securities.  But  this  corporation  was  authorized  to 
discount  for  banks  which  granted  loans  to  firms  (whose 
operations  were  contributory  to  the  prosecution  of  the 
war)  the  promissory  notes  of  the  banks  secured  by  the 
collateral  offered  by  the  firm  to  the  banks.  Also,  loans 
could  be  made  directly  to  such  firms  under  certain  re- 
strictions. Such  loans  might  run  for  five  years.  The 
corporation  could  also  issue  bonds.  By  this  act  the  Re- 
serve Banks  were  allowed  to  discount  the  direct  obliga- 
tions of  member  banks  secured  by  such  bonds  of  the 
corporation  and  to  rediscount  eligible  paper  secured  by 

1  For  the  text  of  the  act,  see  Bulletin,  April,  1918,  pp.  301-306.  For  its 
Annual  Report,  see  Bulletin,  January,  1919,  p.  28.  This  measure  was  in  some 
ways  similar  to  the  resort  in  Germany  to  Darlehnskassen,  which  granted  loans 
that  would  not  be  accepted  by  the  Reichsbank. 


11 


WORKING  OF  FEDERAL  RESERVE  ACT    301 

such  bonds  and  indorsed  by  a  member  bank  (Section  13). 
Banks,  having  made  loans  to  war  industries  not  accep- 
table to  Reserve  Banks,  could  thus  get  advances  from  the 
War  Finance  Corporation.^  Later  the  corporation  was 
permitted  to  aid  exporting  firms. ^ 

In  passing  to  a  matter  of  general  importance,  it  is  to 
be  remembered  that  under  the  original  act  (Section  15) 
the  independent  treasury  system  was  not  abolished.  It 
was  only  provided  that  the  secretary  of  the  treasury 
may  deposit  government  funds  with  the  Federal  Reserve 
Banks. ^  It  was  at  his  discretion  alone  that  funds  were 
sent  to  Southern  Reserve  Banks  in  September,  1915,  to 
help  move  cotton.  It  should  be  noted,  also,  that  since 
the  Reserve  Banks  have  been  made  fiscal  agents  there 
is  no  reason  for  retaining  the  old  subtreasuries  now  be- 
come obsolete/ 

§  8.  The  original  act  of  December  23,  1913,  extended 
the  life  of  the  Aldrich-Vreeland  Acf^  one  year  from  June 
30,  1914,  to  June  30,  1915,  and  reduced  the  tax  on  its 
notes  to  3  per  cent  per  annum  for  the  first  three  months, 
with  an  additional  one-half  per  cent  for  each  month  until 
6  per  cent  was  reached.  In  the  panic  of  1914^  not  only 
were  clearing-house  certificates  to  the  maximum  of  $109,- 

•  The  Capital  Issues  Committee  under  this  act  passed  on  the  question  whether 
issues  of  securities  were  compatible  with  the  public  interest.  It  ceased  to  act 
December  31,  1918,  and  was  dissolved  by  proclamation  August  30,  1919. 

2  See  Liberty  Loan  Act,  March  3, 1919,  Sec.  9.  Bulletin,  March,  1919,  pp.  227- 
228.  Cf.  also  an  amendment  widening  such  loans.  Bulletin,  October,  1919, 
p.  966. 

^  Cf.  supra,  p.  275.  See  Bulletin,  October,  1915,  p.  301,  for  the  first  deposits. 
Also  in  connection  with  the  special  deposit  of  proceeds  of  bond  sales,  under 
the  fiscal  act  of  September  24,  1917,  as  amended  April  4,  1918,  see  Bulletin, 
June,  1918,  p.  494. 

*  See  the  Report  of  the  Bureau  of  Efficiency,  January  26,  1918  (H.  R.  Doc, 
No.  867).     Bulletin,  March,  1918,  pp.  172-178. 

^  See  supra.  Chapter  IV. 

"  See  Laughlin,  Credit  of  the  Nations,  pp.  299-305. 


302  BANKING  PROGRESS 

185,000  issued,  but  the  demand  for  an  emergency  cur- 
rency led  to  an  amendment  of  the  act  of  1908.  The  act 
of  August  4,  1914,  removed  the  prerequisite  to  note- 
issues  of  40  per  cent  of  bond-secured  notes,  raised  the 
total  issue  to  125  per  cent  of  capital  and  surplus,  and 
abolished  the  limit  of  $500,000,000  to  the  total  circula- 
tion. After  these  amendments  Aldrich-Vreeland  notes 
were  issued  for  the  first  time  to  a  total  of  $381,530,000, 
but  were  all  retired  by  June  30,  1915.  If  the  Federal 
Reserve  Banks  had  been  in  operation,  such  issues  need 
not  have  been  made. 

The  purpose  of  the  Federal  Reserve  Act  was  the  even- 
tual substitution  of  all  bond-secured  national  bank  notes 
by  Federal  Reserve  notes  (Section  18).  As  bonds  of 
the  United  States  were  withdrawn  under  the  act  from 
the  security  for  the  old  national  bank  notes,  and  were 
taken  over  by  the  Reserve  Banks,  these  institutions  were 
allowed  the  option  of  depositing  these  bonds  with  the 
comptroller  and  obtaining  "Federal  Reserve  Bank  notes," 
on  the  same  basis  as  old  national  bank  notes. ^  WTien 
the  p)eriod  arrived,  December  23,  1915,  at  which  national 
banks  could  begin  to  dispose  of  the  bonds  used  to  secure 
their  notes,  the  total  amount  offered  in  the  first  quarter 
was  $16,041,700  as  against  one-fourth  of  the  $25,000,000 
yearly  purchases  allowed.  But  meanwhile  the  Reserve 
Banks  had  been  buying  government  bonds  in  the  open 
market,  which  the  Federal  Reserve  Board  regarded  as 
an  offset  against  any  allotment  from  those  offered  through 
the  treasurer.     In  all  but  one  instance  the  purchases  in 

^  Since  they  are  the  obligations  of  a  Federal  Reserve  Bank  the  words  "na- 
tional currency"  are  engraved  on  the  top  margin  of  the  face  of  the  note  and 
"Federal  Reserve  bank  note"  on  the  bottom  margin  of  the  same  side  of  the 
note.  But  they  differ  as  to  security  and  origin  from  the  Federal  Reserve  notes, 
which  are  obligations  of  the  United  States,  and  which  have  the  words  "Federal 
Reserve  note"  engraved  on  their  face. 


WORKING  OF  FEDERAL  RESERVE  ACT    303 

the  open  market  exceeded  the  quota  to  be  allotted.  Hence 
the  Reserve  Banks  were  not  required  to  buy  any  of  those 
offered  under  Section  18. 

The  conversion  of  2  per  cents  (having  the  circulation 
privilege),  however,  went  on  into  one-year  gold  notes 
and  3  per  cent  SO-year  gold  bonds  (without  the  circula- 
tion privilege)  to  the  amount  of  $30,000,000  for  1916— 
half  and  half  of  each.  The  same  amount  was  converted 
for  1917.  The  conversion  of  bonds  having  the  circula- 
tion privilege  will  thus  tend  to  reduce  the  amount  of  old 
national  bank  notes  outstanding.  But  very  little  use 
was  at  first  made  by  the  Reserve  Banks  of  Federal  Re- 
serve Bank  notes.  Toward  the  end  of  1917  their  amount 
was  only  $12,758,885.^  Under  the  Pittman  Act,  April 
23,  1918,  retiring  silver  certificates  for  silver  melted  and 
exported,  Federal  Reserve  Bank  notes  of  any  denomina- 
tion were  authorized  to  take  their  place.  Accordingly, 
these  notes  were  increased  by  the  close  of  1919  to  $254,- 
933,000.2 

The  old  national  bank  notes  remained  in  the  circula- 
tion very  slightly  changed  in  amount.^  In  1914  there 
were  outstanding  $750,671,899,  and  at  the  end  of  October, 
1919,  $722,394,325.  Of  the  bonds  bearmg  the  circula- 
tion privilege  $63,945,460  of  Spanish -American  War  3 
per  cent  bonds  matured  August  1,  1918;  but  by  the  end 
of  1919  bonds  bearing  the  circulation  privilege  totalled 
$793,115,530.  The  demands  for  circulation  were  strong 
and  the  bonds  remained  practically  unchanged  during 
the  stress  of  war. 

A  most  important  new  element,  however,  was  intro- 
duced by  the  Federal  Reserve  notes.     As  a  consequence 

^  Bulletin,  January,  1918,  p.  18. 
2  Fin.  Rpt.,  1919,  p.  102. 

*  To  help  relieve  the  shortage  of  small  notes,  national  bank  notes  of  less  de- 
nomination than  $5  were  allowed  by  the  act  of  October  5,  1917. 


304  BANKING  PROGRESS 

of  a  remarkable  increase  in  loans  at  the  Reserve  Banks, 
mainly  due  to  borrowings  secured  by  government  war 
obligations,  there  must  be  a  corresponding  increase  of 
demand-liabilities  either  in  the  form  of  deposits  or  notes. 
The  increase  of  Federal  Reserve  notes  was  the  most  signifi- 
cant feature  of  this  period.  It  represented,  moreover,  a 
policy.  There  was  a  natural  reason  for  encouraging  the 
substitution  of  Reserve  notes  for  the  old  national  bank 
notes,  but  there  was  very  little  reduction  in  the  latter. 
The  encouragement  to  the  increase  of  Reserve  notes  must 
rather  be  ascribed  to  the  law  itself  and  their  unfortunately 
too  direct  relation  to  the  increase  of  loans.  That  is  why 
the  emphasis  on  the  separation  of  the  issues  from  loans 
and  deposits  in  Chapter  IX  (Section  8)  seems  to  be  of 
present  and  future  importance.  By  the  time  we  entered 
the  war  the  Reserve  notes  had  already  grown  (March, 
1917)  to  $336,269,000;  but  the  phenomenal  increase  to 
$3,057,646,000  in  actual  circulation  by  the  end  of  1919 
is  obviously  connected  with  conditions  produced  by  the 
war. 

It  was  the  general  policy  to  gather  into  the  Reserve 
Banks  all  the  gold  of  the  country;  and  the  issue  of  Reserve 
notes  whenever  they  could  be  exchanged  for  gold  was  a 
part  of  that  policy.  Early  in  1917^  optimistic  views  were 
held  as  to  the  possible  increase  of  Reserve  notes  as  emer- 
gency-issues up  to  $1,000,000,000  (a  sum  overpassed,  in 
fact,  by  November  of  that  year).  The  main  emphasis 
seems  to  have  been  placed  on  the  new  status  given  to 
Reserve  notes  by  the  act  of  June  21,  1917.  Before  that 
date,  Reserve  notes  could  be  issued  only  on  the  deposit 
of  eligible  paper;  but  this  act  authorized  their  issue  di- 
rectly for  gold  or  gold  certificates;   and,  under  the  pro- 

» Bulletin,  March,  1917,  p.  155. 


WORKING  OF  FEDERAL  RESERVE  ACT    305 

vision  for  a  40  per  cent  gold  reserve  behind  the  notes,  a 
proviso  was  introduced: 

That,  when  the  Federal  reserve  agent  holds  gold  or  gold 
certificates  as  collateral  for  Federal  reserve  notes  issued  to 
the  bank  such  gold  or  gold  certificates  shall  be  counted  as  part 
of  the  gold  reserve  which  such  bank  is  required  to  maintain 
against  its  Federal  reserve  notes  in  actual  circulation. 

That  is,  after  gold  was  obtained  by  federal  reserve  agents 
in  direct  exchange  for  notes,  only  40  per  cent  of  such 
gold  need  be  regarded  as  legal  gold  reserve  behind  the 
notes,  and  the  remainder  could  be  regarded  as  surplus 
gold  or  as  protection  against  deposits  (after  substituting 
eligible  paper  for  all  beyond  40  per  cent  of  gold  as  pro- 
tection to  the  notes). ^  This  plan  to  collect  gold  was  also 
furthered  by  not  requiring  member  banks  to  carry  there- 
after any  reserves  in  their  own  vaults.  In  addition,  Re- 
serve notes  could  be  issued  upon  the  security  of  15-day 
notes  of  member  banks  secured  not  merely  by  eligible 
paper,  but  by  government  obligations.  It  can  be  seen 
that  the  policy  to  encourage  the  issue  of  Reserve  notes 
was  furthered  by  all  these  provisions.  Although  a  35 
per  cent  reserve  is  held  for  deposits  in  gold  or  lawful 
money,  it  is  quite  clear  that  the  holding  of  one  gold  re- 
serve equally  for  the  two  demand-liabilities,  notes  and 
deposits,  shifting  from  one  to  the  other,  is  a  reversion 
from  the  well-recognized  policy  of  a  separate  reserve  for 
notes  back  to  the  older  and  supposedly  obsolete  system 
of  the  old  United  States  Banks  and  the  State  banks  in 
the  early  part  of  the  last  century.  Nor  does  there  seem 
to  be  any  justification,  especially  in  the  very  great  ex- 
pansion of  notes,  for  this  retrogression.  At  the  Bank  of 
England,  beyond  a  stratum  of  £18%  millions  of  consols, 

» Bulletin,  July,  1917,  pp.  503-504,  506-507,  510,  515. 


306  BANKING  PROGRESS 

there  is  a  pound  of  gold  for  every  pound  note.  Since 
1838  and  under  the  national  banking  system  also  it  has 
been  American  policy  to  separate  reserves  for  notes  from 
reserves  for  deposits. 

It  is  not  easy  to  account  satisfactorily  for  the  extraor- 
dinary increase  in  the  Reserve  notes.  Before  their  time 
our  currency  (national  bank  notes,  greenbacks,  etc.)  was 
inelastic.  It  is  possible  that  when  a  really  elastic  cur- 
rency was  created  in  the  Reserve  notes  there  was  revealed 
a  larger  demand  than  was  suspected  for  a  medium  of 
exchange.  So  far  as  this  is  true  there  was  no  inflation; 
for,  as  immediate  redemption  in  gold  is  maintained,  any 
excess  would  be  returned  at  once.  It  may  be  interesting 
to  note  what  calls  could  be  made  for  these  new  notes. 
As  gold  moved  into  the  Reserve  Banks,  Reserve  notes 
would  take  their  place  in  the  hands  of  the  public.  In 
fact,  the  gold  holdings  of  the  Reserve  Banks  amounted 
(December  26,  1919)  to  two-thirds  of  the  notes  in  cir- 
culation. And  in  the  year  from  July  1,  1918,  the  gold 
certificates  in  circulation  diminished  by  $287,991,138.^ 
Moreover,  non-member  banks  no  doubt  carry  Reserve 
notes  in  their  reserves.  As  they  were  permitted  to  borrow 
on  security  of  war  obligations  through  member  banks  they 
could  thereby  increase  their  lending  power  by  calling  for 
Reserve  notes.  Thus  the  desire  to  sell  bonds  must  have 
led  to  an  increase  of  notes  and  to  a  considerable  expansion 
of  loans  by  banks  outside  of  the  reserve  system.  Again, 
it  is  probable  that  during  the  war  the  amounts  absorbed 
by  the  public  in  circulation  were  greatly  increased. 
Those  who  did  not  deposit  in  banks  came  into  possession 
of  more  money  than  ever  before.  Wages  had  been  greatly 
increased,  and  the  workers  retained  currency  in  large 
sums.     An   increase   of   only   $50   per   capita    in    these 

>  Finance  Report,  1919,  p.  563. 


WORKING  OF  FEDERAL  RESERVE  ACT    307 

classes  would  account  for  almost  the  whole  increase 
in  the  Reserve  notes.  In  addition,  the  rise  of  prices  from 
100  to  219  would  require  more  than  twice  as  much  money 
to  be  passed  from  hand  to  hand  for  the  same  quantity 
of  goods  as  were  exchanged  in  1914.  It  is  also  stated 
that  much  of  our  currency  (almost  the  only  one  in  the 
world  equal  in  value  to  gold)  was  drawn  off  to  Canada, 
Mexico,  Cuba,  Philippine  Islands,  Hawaii,  Porto  Rico, 
Santo  Domingo,  Haiti,  Honduras,  and  Panama.^  If 
these  notes  were  redundant  it  would  be  quickly  shown 
by  the  redemptions;  but  there  has  been  little  evidence 
of  a  redundancy  as  yet.  The  increase  in  Reserve  notes^ 
at  various  dates  may  be  stated  as  follows: 


[In  millions] 


Reserve  notes 


All  money  out- 
side Treasury 
and  Federal  Re- 
serve system 


April  4,  1917 

June  27,  1917 

November  21,  1917 

April  18,  1918 

August  22,  1918... 
October  17,  1918 .  . 
October  10,  1919.  . 
December  26,  1919 . 


!  876.5 
508.8 
1,015.8 
1,514.2 
2,032.8 
2,502.4 
2,741.6 
8,057.6 


N!,100.9 

4,i3i!i 
4,266.8 
4,449.8 
4,925.9 
4,958.9 
6,172.2 


It  will  thus  be  seen  that  from  our  entrance  into  the  war, 
the  Reserve  notes  increased  far  more  than  the  total  money 
in  circulation;  that  from  November,  1917,  the  increase 
of  Reserve  notes  was  over  a  billion  dollars  more  than  the 
total.  It  is  likely  that  not  all  of  this  increase  was  needed 
as  a  medium  of  exchange.^ 

» Fin.  Report,  1919,  p.  20. 

*  Bulletin,  November,  1919,  p.  1046,  and  January,  1920,  p.  109. 

•  The  discretionary  charge  of  a  rate  of  interest  on  the  notes  to  force  retire- 
ment was  never  used.  Bulletin,  June,  1916,  p.  273.  A  separate  rate  on  notes 
issued  under  the  War  Finance  Corporation  Act  could  be  charged. 


308  BANKING  PROGRESS 

§  9.  Whatever  the  system  of  banking,  in  whatever 
country,  the  test  of  its  management  and  the  soundness  of 
its  condition  is  to  be  found  in  the  character  of  its  assets. 
By  the  very  nature  of  a  commercial  bank,  as  distinct 
from  a  mortgage  company  or  a  savings-bank,  its  im- 
mediate liabilities — its  demand  deposits  and  notes — de- 
pend for  their  payment  on  the  assets  being  liquid  and 
quickly  convertible  into  cash.  That  is  the  reason  why 
short-term  paper  is  essential  to  liquidity.  The  cash  re- 
serves are  only  a  stop-gap.  If  loans  were  not  based  on 
transactions  whose  proceeds  would  liquidate  the  loans 
at  their  maturity,  cash  reserves,  no  matter  how  large, 
would  soon  be  used  up.  When  that  happens,  even  with 
great  but  unliquid  assets,  a  bank  must  suspend  payrdent 
and  go  into  liquidation.  The  difference  between  success 
and  failure  lies  in  the  ability  to  maintain  liquid  assets. 
How  far  the  Federal  Reserve  system  has  travelled  on 
this  dangerous  road  it  is  our  duty  to  report. 

An  expansion  of  credit  is  not  to  be  tested  by  the  quan- 
titj'  of  its  demand-liabilities — its  deposits  and  its  notes — 
but  by  the  liquidity  of  its  assets  in  the  loan  item.  No 
matter  how  large  these  two  forms  of  immediate  liability, 
for  which  cash  can  be  demanded  at  any  moment,  if  loans 
are  being  constantly,  day  by  day,  paid  off  and  new  ones 
of  the  same  quality  taking  their  place,  in  totals  as  large 
as  their  liabilities,  then  all  is  safe.  The  Federal  Reserve 
Board,  in  a  different  way,  defined  inflation  "as  the  proc- 
ess of  making  additions  to  credits  not  based  upon  a  com- 
mensurate increase  in  the  production  of  goods."  ^  If  this 
means  that  loans  made  on  commercial  paper  directly  re- 
lated to  the  production  and  sale  of  staple  goods  could  not 
lead  to  inflation,  then  it  would  follow  that  loans  made  on 

^  Bulletin,  July,  1919,  p.  614. 


WORKING  OF  FEDERAL  RESERVE  ACT    309 

unliquid  assets  would  inevitably  lead  to  inflation.  That 
there  has  been  an  expansion  of  credit,  practically  result- 
ing in  drawing  down  our  ratio  of  reserves  to  demand- 
liabilities  to  the  danger-point,  there  can  be  no  doubt. 
Nor  is  the  cause  of  this  expansion  in  any  way  obscure. 
Whether  we  could  have  escaped  it  or  not,  the  fact  is  that, 
as  a  result  of  mixing  banking  with  the  fiscal  operations  of 
the  Treasury,  the  banks  of  the  country  have  become 
heavily  loaded  with  more  or  less  unliquid  assets  in  the 
form  of  war  obligations  and  war  paper,  amounting  in 
June,  1919,  to  $6.5  billions.^  The  amount  of  war  paper, 
or  loans  on  collateral  of  war  obligations,  was  about  $2.5 
billions.  That  this  very  large  increase  of  loans  was  fol- 
lowed by  an  increase  of  notes  and  deposits  goes  without 
saying.  Nor  can  these  demand-liabilities  be  reduced 
until  the  loans  have  been  paid  off. 

As  early  as  the  summer  of  1917,  after  the  first  war  loan 
and  the  passage  of  the  act  of  June  21,  1917,  there  were 
suggestions  as  to  undue  expansion.  There  was  already 
a  relative  increase  of  war  paper  and  a  relative  decrease 
of  commercial  paper.  The  extension  of  acceptances  was 
side-tracked.  It  was  assumed  that  the  loans  to  buyers 
of  bonds  would  be  temporary,  and  rather  light-heartedly 
war  paper  was  encouraged  by  being  given  a  preferential 
rate  of  discount  even  over  good  commercial  paper.^  In 
truth,  the  reverse  ought  to  have  been  the  policy,  so  that 
saving  and  the  liquidation  of  war  paper  would  have  been 
forced,  especially  if  other  government  loans  were  certain 
to  follow.  Toward  the  end  of  1917  the  board  clearly 
saw  the  danger  from  unliquid  assets.  Already  the  financ- 
ing of  British  short-term  notes,  made  the  basis  for  ac- 

1  Bulletin,  October,  1919,  p.  943. 

2  Bulletin,  June,  1917,  pp.  425,  430,  and  October,  1918,  p.  922. 


310  BANKING  PROGRESS 

ceptances,  but  to  be  successively  renewed,  had  been 
tabooed  as  creating  unliquid  assets.  Also,  the  same 
method  for  domestic  corporations  was  opposed,^  the 
board  saying; 

The  system  must  use  every  effort  to  maintain  its  liquid 
character  and  .  .  .  commercial  paper  regarded  as  eligible  for 
discount  must  be  of  a  kind  calculated  to  provide  its  own  means 
of  hquidation.  Admission  of  long-term  obligations,  or  obliga- 
tions short-term  in  form  only,  .  .  .  was  regarded  as  unques- 
tionably opening  an  avenue  of  danger  to  the  system. 

But  yet,  obligations  of  our  government  were  admitted 
as  a  basis  of  loans,  even  though  it  produced  unliquid  as- 
sets. In  the  year  1918,  with  its  succession  of  enormous 
government  loans,  the  expansion  rapidly  proceeded.  In 
February  renewals  by  member  banks  were  noted.  The 
securities  owned  by  the  banks  increased  markedly,  the 
national  banks  alone  having  added  by  the  end  of  1917 
$910,000,000.  By  October,  1918,  the  total  mvestments 
of  Reserve  Banks  had  risen  to  $2,295,000,000,  and  of 
member  banks  to  $14,022,000,000.  As  a  consequence, 
deposit-liabilities  of  Reserve  Banks  rose  to  $1,580,000,000, 
and  of  member  banks  to  $11,731,000,000.2  Meanwhile 
the  percentage  of  cash  reserves  to  deposits  and  notes  which 
had  been  over  80  in  the  summer  of  1917,  fell  to  nearly  50' 
by  the  end  of  1918,  and  at  the  end  of  1919  to  44.8  (while 
at  the  Reserve  Bank  of  New  York  it  was  about  40  in  No- 
vember, 1919).  Since  then  it  has  fallen  even  lower.  The 
whole  situation  of  the  Reserve  Banks  may  be  seen  from 
the  account  of  December  26,  1919: 

'  BuMin,  December,  1917,  p.  922.    C/.  iUd.,  1918,  p.  249. 

2  Bulletin,  November,  1918,  p.  1048. 

» See  table,  Bulletin,  February,  1919,  p.  187. 


11 


WORKING  OF  FEDERAL  RESERVE  ACT    311 

[In  millions] 


Liabilities 

CapiUlpaid  in $       87.3 

Surplus 81.1 

Deposits : 

Government  deposits. ...       72 . 3 

Due    to    members    (re- 
serve account) $1,786.9 

Deterred      availability 

items 82^2.7 

Other  d^wsits 97 .7 

Total  gross  deposits 2,779.6 

Notes  is  circulation: 

Federal  Reserve  notes 3,057.6 

Federal  Reserve  Bank  notes. ...  261 .0 

Other  liabilities 58.8 


Resources 

Discounts: 
Secxired  by  government 

war  obligations $1,510.4 

All  other 684.5 

Bills  bought  open  market. .  685 . 2 

Government  bonds 26.8 

Victory  notes .1 

U.  S.  certificates  of  indebt- 
edness   «73.5 

Total  earning  assets $8,080.6 

Cash: 

Gold  and  gold  certificates  229 . 4 
Gold  Settlement  Funds . .  3fi2 . 8 
Gold  with  foreign  agen- 
cies   134. S 

Gold  with  reserve  agents  1,240 . 0 

Gold  Redemption  Fund.  121.9 

Total  gold  reserves 2,078 . 4 

Legal-tender  notes,  silver, 

etc 67.1 

Total  cash 2,185.5 

Uncollected  items 1,075. 1 

6  per  cent  Redemption  Fund  (Fed- 
eral Reserve  Bank  notes) 13.2 

Bank  premises 13 .0 

All  other  resources 8.1 

Total  resources $6,325 .4 


Total  liabilities $6,325.4 


When  examining  the  condition^  of  member  banks, 
however,  at  the  end  of  1919  we  find  the  expansion  of 
loans  not  so  much  in  carrying  government  securities  as 
in  other  paper: 

[In  millions] 


Loans  secured  by  U.  S.  obligations $1,022 . 7 

Loans  secured  by  other  than  U.  S.  stocks  and  bonds 3,270 . 6 

All  other  loans  and  investments 9,339 . 9 

Total  U.  S.  securities  owned 1,981 .7 

Total  loans  and  investments $15,614 . 8 


>  Bulletin,  January,  1920,  pp.  103-104.  Figures  are  not  given  by  which  a 
comparison  can  be  made  with  conditions  before  we  entered  the  war,  April, 
1917. 


312  BANKING  PROGRESS 

Against  these  assets  there  were  liabilities: 

[In  millions] 


Net  demand-deposits $11,195 . 1 

Time-deposits 2,293.4 

Government  deposits 647 . 9 

$14,136.4 

Reserve  balance  with  Federal  Reserve  Bank 1,316 . 9 

Cash  in  vault 403.5 


Total  reserves $1,720  4 


In  this  account  the  character  of  "all  other  loans"  is  far 
more  important  than  that  of  the  war  paper.  Moreover, 
of  bUls  rediscounted  with  Reserve  Banks,  only  $306.3 
millions  were  secured  by  government  war  obligations. 
Of  bills  payable  with  Reserve  Banks,  $841.4  millions  were 
thus  secured.  It  seems  to  be  clear  that  the  expansion 
of  credit  was  by  no  means  confined  to  war  paper. 

§  10.  It  would  have  been  surprising  if  any  banking 
system  could  have  been  created  which  would  not  have 
shown  some  defects  of  structure  under  the  phenomenal 
and  unparalleled  strains  of  the  European  War.  Nor  is 
it  to  be  expected  that  no  mistakes  of  policy  should  have 
been  made  by  the  management. 

First  of  all  the  lessons  to  be  learned  from  our  unusual 
experience  is  that  there  is  need  of  better  control  over 
undue  expansion  of  credit.  For  a  time  the  ofiicial  publi- 
cations of  the  board  showed  a  naive  jubilation  at  the  un- 
limited banking  power  of  the  system.  This  policy  had 
a  tendency  to  encourage  a  resort  to  the  system  for  pur- 
poses inconsistent  with  the  fundamental  purposes  of  the 
act.  No  banking  system  can  look  forward  to  an  inex- 
haustible fund  of  credit.  Limitations  are  set  by  the 
amount  of  available  banking  capital,  the  thrift  of  the 
community  by   which  alone  additional  capital  can  be 


WORKING  OF  FEDERAL  RESERVE  ACT    313 

supplied,  and  by  the  turnover  of  staple  goods  which  is 
dependent  on  the  efficiency  of  the  productive  processes 
in  the  various  industries.  It  was  amazing  that,  in  spite 
of  other  demands,  our  people  could  supply  in  taxes  and 
loans  to  the  government  the  means  to  cover  the  cost  of 
the  war  (about  $34,000,000,000).  When  the  need  of 
credit  from  the  banks  was  called  upon  in  placing  enor- 
mous loans,  it  was  obvious  that  continuing  industrial 
needs  must  also  be  cared  for.  By  the  end  of  1919  the 
combined  demands  of  both  these  factors  had  practically 
reached  the  limits  of  our  banking  power.  Even  though 
commercial  needs  were  restricted  it  was  properly  urged 
that  necessary  operations  must  be  hindered  unless  assets 
in  the  form  of  war  paper  were  taken  up  by  the  public. 
This  was  only  an  appeal  for  more  capital  through  new 
saving  by  subscribers  to  loans. 

It  is  a  question  whether  the  inevitable  limitations  of 
credit  were  sufficiently  foreseen  and  duly  provided  for. 
As  we  have  noted,  the  fear  of  inflation  was  present  in 
1917  and  frequently  stated.  But  what  was  done  to  pre- 
vent it.f^  The  time-honored  remedy  was  the  increase  in 
the  charge  for  loans.  The  board  asserted  that  it  was  not 
possible  to  raise  the  rate  of  discount  while  government 
loans  were  being  placed.  It  is  not  certain,  however,  that 
a  higher  rate  on  war  paper  would  have  so  reduced  the 
patriotic  feeling  of  the  country  that  the  loans  would  not 
have  been  subscribed  for.  Subscriptions  in  general  would 
hardly  have  been  antagonized  by  so  relatively  small  a 
matter  as  the  rate  to  borrowers  on  the  part  of  the  loans 
which  required  bank  credit.  For  war  paper  the  prefer- 
ential rate  was  of  questionable  wisdom.  It  encouraged 
borrowing  on  the  security  of  bonds,  as  compared  with 
liquid  commercial  paper.  Under  general  principles  war 
paper  ought  to  have  been  charged  a  higher  rate.     The 


314  BANKING  PROGRESS 

application  of  the  break  on  expansion  of  credit  by  a  higher 
rate  of  discoimt  should  have  come  before  a  serious  emer- 
gency had  arisen.  In  fact,  any  real  attempt  to  raise 
rates  did  not  appear  before  November,  1919,  when  the 
limits  to  credit  were  close  before  us.  A  more  courageous 
and  far-sighted  policy  would  have  been  better. 

It  would  be  well  to  consider  also  whether  it  had  not 
been  better  to  rule  against  the  tendency  to  expansion  at 
its  source  by  automatically  adding  a  sliding  scale  of  com- 
missions to  the  rate  of  discount  charged  a  member  bank 
as  its  rediscounts  rose  relatively  to  its  capital.  This  was 
proposed  but  passed  by  when  the  act  was  adopted.^ 

Moreover,  the  concentration  of  reserves,  especially  of 
gold,  had  been  heralded  as  a  mighty  power  for  good. 
The  convergence  of  gold  into  the  hands  of  the  Reserve 
Banks  was  accomplished;  but  it  created  a  dangerous 
overconfidence.  Even  an  abnormally  high  fund  of  gold 
is  limited  in  its  power.  Already  the  deposits  and  notes, 
as  the  result  of  expansion,  are  so  large  that  the  reserve 
requirements  leave  no  great  margin  of  "free  gold."  A 
change  in  international  trade  which  would  call  for  gold 
exports  would  be  serious.  A  further  growth  of  business 
would  be  met  by  the  fact  that,  outside  of  the  sums  in 
the  Reserve  Banks,  there  is  no  considerable  amount  of 
gold  in  the  country  to  be  drawn  upon.  Our  exports  may 
not  for  long  continue  to  give  us  control  of  foreign  gold, 
even  if  it  were  available. 

A  much  more  important  matter,  and  one  that  is  struc- 
tural, arises  from  the  provisions  of  the  act  regarding  notes. 
Unhappily,  the  act  shows  the  influence  of  an  attitude  of 
mind  leaning  toward  Continental  rather  than  toward 
British  or  American  banking  traditions.     To  be  sure, 

*  See  supra,  p.  172.  A  bill  is  before  Congress  (April,  1920)  to  accomplish 
this  very  purpose. 


WORKING  OF  FEDERAL  RESERVE  ACT    315 

there  has  always  been  with  us,  since  greenback  days,  an 
inclination  in  some  quarters  to  believe  in  the  potency  of 
note-issues  in  times  of  emergency.  This  has  already  been 
noted  in  connection  with  our  panic  of  1907.^  But  the 
whole  spirit  of  our  banking  progress  in  recent  years  had 
been  toward  the  organization  of  credit  and  the  placing  of 
our  media  of  exchange  on  an  elastic,  automatic  basis  in- 
dependent of  fiscal  operations.  To  give  the  Federal  Re- 
serve notes  safety  and  elasticity  by  admitting  commer- 
cial paper  as  a  protection  (with  an  additional  gold  reserve 
of  40  per  cent)  did  not  imply  any  necessity  for  confusing 
the  quantity  of  note-issues  with  fiscal  operations,  or  with 
general  banking  operations  carried  on  by  the  check-and- 
deposit  system,  so  well  established  here  and  in  Great 
Britain.  Since  1844  an  expansion  of  British  credit  at  the 
banking  department  of  the  Bank  of  England  has  gone  on 
independently  of  the  security  of  the  bank-notes  put  out 
by  the  issue  department.  During  the  war  Bank  of  Eng- 
land notes  were  not  expanded  by  the  fiscal  operations  of 
the  Treasury.  The  one  great  blunder  was  the  issue  of 
currency  notes  (government  paper)  as  a  means  of  bor- 
rowing, the  only  measure  which  has  seriously  threatened 
the  British  gold  standard.  On  the  other  hand,  on  the 
Continent,  and  especially  in  France  and  Germany — 
where  notes,  not  checks  drawn  on  deposits,  form  the 
main  medium  of  exchange — government  borrowings  led 
directly  to  an  enlargement  of  bank-notes.  The  outcome 
of  this  system  in  Germany  has  been  a  submergence  of 
the  note-issues  under  fiscal  borrowings  from  the  Reichs- 
bank  and  the  depreciation  of  the  notes  almost  to  the 
level  of  our  old  colonial  currency.  Under  the  Federal 
Reserve  Act  we  have,  unfortimately,  inclined  to  Con- 
tinental precedents,  and  not  fully  separated  our  Reserve 

'  See  supra.  Chapters  III,  IV,  and  VII. 


316  BANKING  PROGRESS 

notes — now  our  chief  currency — from  the  fiscal  opera- 
tions of  the  Treasury  and  the  purely  credit  functions  of 
discount  and  deposit. 

As  already  mentioned — oblivious  to  our  own  character- 
istic American  development  away  from  the  methods  in 
existence  before  1838  by  which  notes  were  mixed  up  with 
credit  operations — we  seem  to  have  drifted  back  to  what 
is  practically  one  reserve  of  gold  for  both  demand-liabili- 
ties, notes  and  deposits.^  When  we  entered  the  war,  Re- 
serve Bank  statements  gave  a  separate  percentage  of  the 
reserve  for  notes  and  for  deposits,  but  by  the  beginning 
of  1918,  when  the  percentage  of  reserves  had  fallen  from 
above  80  to  65,  the  percentage  is  given  for  the  two  com- 
bined liabilities.  Therein  lies  a  tendency  to  an  unde- 
sirable end.  When  the  40  per  cent  reserve  in  gold  for 
notes  is  subtracted  from  cash  no  considerable  excess  re- 
mains above  the  35  per  cent  for  deposits.  That  is,  an 
increase  of  loans  and  so  of  deposits  would  alter  the  per- 
centage of  gold  reserves  and  leave  less  for  notes.  And, 
as  we  have  said,  there  is  now,  since  the  concentration  of 
gold  in  the  Reserve  Banks,  no  large  stock  of  outside  gold 
on  which  to  draw.  The  chart^  published  by  the  board 
for  1918  shows  a  very  remarkable  decline  in  the  per- 
centage of  cash  reserves  to  deposit  and  note  liabilities, 
due  almost  entirely  to  a  rapid  increase  of  Reserve  notes. 
From  the  point  of  view,  therefore,  of  banking  principles 
and  experience,  there  ought  to  be  no  such  close  dependence 
of  both  notes  and  deposits  on  one  gold  reserve.  The 
experience  of  Germany  ought  to  be  conclusive;  while 
the  steady  movement  of  our  own  system  by  the  end  of 
1919  in  the  same  direction  ought  to  force  us  to  study 
the  matter  fully  presented  in  the  proposed  bill  of  Chapter 


1  Cf.  supra,  pp.  16,  106,  135,  189,  256,  288,  305. 
'  Bulletin,  January,  1919,  p.  67. 


II 


WORKING  OF  FEDERAL  RESERVE  ACT    317 

IX  (Section  8).  The  amount  and  convertibility  of  our 
Reserve  notes  ought  in  no  way  to  be  determined  by  fiscal 
operations. 

Also,  it  should  be  remembered  that  there  are  yet  non- 
member  banks  who  can  use  Reserve  notes  in  their  reserves. 
Hence,  their  expansion  of  credit  can  go  on  as  long  as  loans 
based  on  government  securities  can  be  rediscounted  and 
notes  be  obtained  thereby.  The  great  task  now  immedi- 
ately before  us  is  to  reconstruct  the  provisions  of  the 
Federal  Reserve  Act  in  such  a  way  as  to  place  the 
quantity  and  the  redeemability  of  the  Federal  Reserve 
notes  above  all  influences  arising  from  the  fiscal  opera- 
tions of  the  Treasury,  or  from  the  heaping  up  of  un- 
liquid  assets  of  any  kind. 


APPENDIX  I 

PLAN  OF  THE  AMERICAN  BANKERS' 
ASSOCIATION 

At  a  meeting  of  the  Currency  Commission  of  the  American  Bank- 
ers' Association,  held  in  Chicago,  January  18,  1908,  there  were  laid 
before  it  the  Aldrich  Bill  and  the  Fowler  BUI.  These  bills  were  read 
section  by  section  and  discussed,  and  their  provisions  carefully  con- 
sidered. After  thorough  discussion  the  Commission  reported  as  fol- 
lows: 

ALDRICH  BHL 

This  bill  proposes  the  issuing  of  additional  bank  notes  based  upon 
the  security  of  other  than  United  States  bonds;  namely,  obligations 
of  State,  city  or  coimty,  and  first  mortgage  railway  bonds.  It  is  be- 
lieved that  this  scheme  is  impracticable,  unwise  and  financially  un- 
sound. 

I.  It  is  a  departure  from  a  safe  system  of  note  issues,  which  has 
been  enjoyed  since  the  foundation  of  the  National  banking  system; 
it  is  a  step  backwards  to  the  conditions  which  gave  rise  to  the  issuing 
of  "wild-cat"  currency  before  the  CivU  War,  which  currency  was 
based  upon  bonds  of  a  similar  description.  It  may  be  the  entering 
wedge  to  the  acceptance  of  undesirable  bonds  as  security  for  note 
issues.  There  are  recent  examples  in  the  laws  of  New  York  State 
legalizing  such  bonds  for  Savings  Banks. 

H.  The  bill  would  not  aid  the  business  public  in  obtaining  loans 
from  banks  in  time  of  stress.  In  its  practical  operation  it  would 
cripple  the  lending  power  of  the  banks.  Inasmuch  as  it  is  not  good 
banking  pohcy  to  hold  any  considerable  amounts  of  such  securities  in 
the  assets  of  commercial  banks,  the  banks  wishing  to  take  out  a  new 
circulation  would  be  obliged  to  purchase  the  new  securities  or  to  bor- 
row them.  The  direct  means  of  obtaining  securities  not  generally 
held  in  the  assets  of  the  banks,  would  be  foiuid  only  by  taking  from 
their  cash  reserves  one  hundred  thousand  dollars  in  lawful  money, 
in  order  to  issue  notes  of  seventy-five  thousand  dollars.  By  this  proc- 
ess the  bank  would  decrease  its  lawful  reserves,  which  form  the  basis 
of  loans.  If  the  bonds  behind  these  notes  were  borrowed  instead  of 
purchased,  it  would  have  the  effect  of  increasing  the  liabilities  of  the 

319 


320  APPENDIX  I 

banks,  which  is  wrong  in  principle  and  pernicious  in  practice.  One 
hundred  thousand  dollars  in  lawful  reserves  would  support  loans  of 
four  himdred  thousand  dollars;  while  under  the  Aldrich  Bill,  one  hun- 
dred thousand  dollars  taken  from  the  reserves  and  invested  in  bonds, 
would  only  permit  the  lending  of  seventy -five  thousand  dollars. 
Thus,  in  its  practical  operation,  it  would  seriously  impair  the  ability 
of  banks  to  meet  the  demands  of  the  borrowing  public. 

ni.  This  bill  would  tend  to  induce  counties  and  municipalities  to 
enlarge  their  obligations,  because  a  fictitious  bond  market  would  be 
created.  It  would  set  a  premium  upon  the  increase  of  local  indebted- 
ness, which  would  be  highly  detrimental.  It  should  be  no  part  of 
Government  legislation  to  aid  in  marketing  securities. 

IV.  The  necessity  of  ascertaining  definite  information  as  to  popu- 
lation of  cities,  debt  limits,  valuation  of  taxable  property,  defaults, 
dividends  on  railway  capital,  and  all  other  technical  requirements, 
would  entail  such  delaj's  as  to  make  the  notes  available  only  after  the 
emergency  had  passed.  A  crisis  is  short,  sharp  and  decisive;  and  the 
Aldrich  Bill  is  a  remedy  offered  to  a  man  after  recovery  or  death. 

V.  The  provision  of  the  Aldrich  Bill  to  tax  such  additional  notes 
six  per  cent  will  make  their  cost  prohibitive.  Calculated  on  a  basis 
of  one  hundred  thousand  dollars  of  bonds  purchased  at  par,  bearing 
four  per  cent  per  annum,  and  estimating  the  lending  rate  of  money  to 
be  six  per  cent,  the  net  loss  to  banks  taking  out  such  circulation,  would 
be  two  thousand  dollars  per  annum,  or  at  the  rate  of  two  per  cent. 

Illustration: 

cost  of  taking  out  notes  against  purchased  bonds 

$100,000  loanable  at  six  per  cent $6,000 

Tax  at  six  per  cent  on  $75,000 4,500 

Total  cost $10,500 

Four  per  cent  int.  on  $100,000  of  bonds $4,000 

Loan  $75,000  at  six  per  cent 4,500 

Total  income 8,500 

Net  loss $2,000 

This  calculation  does  not  include  loss  of  interest  on  redemption 
fund  nor  the  cost  of  printing  and  redemption  of  notes.  When  the 
price  of  such  bonds  becomes  inflated  by  reason  of  their  use  as  a  basis 
of  circulation,  as  in  the  case  of  United  States  bonds,  the  cost  of  the 
notes  would  be  proportionately  increased.  If  the  bonds  were  bor- 
rowed instead  of  purchased,  the  cost  of  notes  issued  would  be  the 
same. 


I 


APPENDIX  I  321 

Illubtbation: 

cost  of  taking  out  notes  against  borbowed  bonds 

Tax  on  $75,000  notes  at  six  per  cent $4,500 

Int.  paid  for  use  of  $100,000  bonds  at  two  per  cent 2,000 

Total  cost $6,500 

INCOME 

Sjx  per  cent  interest  on  $75,000 4,500 

Net  loss $2,000 

Calculation  Is  exclusive  of  loss  of  interest  on  redemption  fund,  and 
the  cost  of  printing  and  redemption  of  notes. 

It  is  thus  proven  that  should  banks  be  forced  to  take  out  these 
notes,  the  minimum  rate  to  the  borrower  would  be  the  actual  cost  of 
eight  per  cent,  independent  of  any  charge  for  the  use  of  the  capital, 
the  expenses  of  doing  business,  and  the  risk  of  lending.  If  fair  allow- 
ance be  made  for  all  legitimate  charges,  the  net  cost  to  borrowers 
would  be  as  high  as  the  prohibitive  ten  per  cent  tax  now  imposed  by 
the  Government  on  State  bank  issues. 

VI.  The  high  cost  of  taking  out  these  notes  must  obviously  be 
paid  by  the  needy  borrower;  and  in  that  event  the  bill  must  be  re- 
garded as  a  measure  operating  to  tax  the  customer  in  a  time  when  he 
especially  requires  assistance.  Under  normal  conditions,  a  seasonal 
"demand,  arising  in  the  autumn,  causes  higher  rates  of  interest;  while 
under  the  operation  of  the  Aldrich  Bill,  the  charge  for  currency  needed 
in  those  periods,  would  be  still  further  increased  to  the  borrower. 
The  enforced  rise  of  interest  rates  would  not  only  apply  to  loans 
effected  by  the  use  of  such  notes,  but  would  at  the  same  time  increase 
the  rates  on  the  entire  line  of  discounts  carried  by  a  bank,  thus  im- 
posing a  heavy  and  unnecessary  burden  upon  the  agricultural  and 
business  interests  of  the  whole  community.  For  these  reasons,  the 
Commission  finds  itself  obliged  to  express  its  disapproval  of  the 
Aldrich  Bill. 

THE  FOWLER  BILL 

After  deliberate  consideration  of  all  the  provisions  of  House  Bill 
12677,  Sixtieth  Congress,  known  as  the  New  Fowler  Bill,  we  disap- 
prove it.  While  It  contains  certain  meritorious  features,  It  Introduces 
schemes  so  far-reaching  In  their  scope  and  touching  so  many  collateral 
interests  not  germane  to  the  real  solution  of  our  currency  difficulties, 
that  we  believe  its  passage  would  unsettle  rather  than  improve  finan- 
cial conditions. 

Let  us  not  be  unmindful  of  the  fact  that  In  response  to  the  de- 
mands of  the  people  unsound  and  radical  legislation  has  had  its  prece- 


322  APPENDIX  I 

dents  in  our  monetary  history.  After  the  panic  of  1873  the  demand 
for  some  action  with  reference  to  currency  was  so  strong  that  Con- 
gress passed  a  bill  increasing  greenbacks  by  forty-four  million  dollars, 
a  project  which  was  wisely  vetoed  by  President  Grant.  After  the 
panic  of  1893,  Congress  gave  its  approval  to  a  measure  providing  for 
the  coinage  of  fifty-five  million  dollars  of  silver,  which  was  vetoed  by 
President  Cleveland,  who  followed  the  excellent  precedent  estabhshed 
by  President  Grant. 

In  these  two  instances  we  have  had  examples  of  hasty  measures 
following  financial  panics,  and  in  the  two  bills  herein  discussed  we 
have  what  appears  to  us  to  be  similar  unwise  measures  following  the 
recent  crisis. 

THE  BANKERS'  PLAN 

The  principles  enunciated  by  the  Commission,  and  approved  by 
the  American  Bankers'  Association  in  convention  assembled  at  At- 
lantic City  on  September  23,  1907,  have  been  at  this  time  carefully 
reviewed,  and  we  are  still  firm  in  the  belief  that  they  are  economically 
sound.  We  have  accordingly  prepared  a  plan  embodying  these  prin- 
ciples. 

The  difiference  between  the  original  plan  of  the  Commission  (em- 
bodied in  House  Bill  23017,  Fifty-ninth  Congress)  and  the  present 
plan  is  to  be  found  in  the  provision  that  the  holder  of  a  credit  note, 
instead  of  being  a  general  creditor,  shall  have  a  prior  lien  on  the  assets 
of  the  issuing  bank.  The  notes  thus  issued  would  be  automatically 
adjusted  in  volume  to  the  demands  for  currency.  The  security  to 
the  notes  thus  provided  h^'  pledging  the  whole  of  the  assets  of  a  bank 
would  afford  more  desirable  protection  to  a  note  holder  than  a  p>or- 
tion  of  those  assets  in  a  segregated  form;  and  such  notes  can  be  issued 
under  provisions  which  will  insure  absolute  safety  to  the  note  holder; 
an  ample  supply  of  currency  to  the  public;  relief  from  the  disturbed 
commercial  conditions,  such  as  those  through  which  we  have  recently 
passed ;  and  finally  the  certain  retirement  of  the  notes  when  they  have 
fulfilled  their  purpose  in  the  hands  of  the  public.  The  plan  proposed 
by  the  Commission  is  as  follows: 

Section  1.  Be  it  enacted  by  the  Senate  and  House  of  Represen- 
tative* of  the  United  States  of  America,  in  Congress  Assembled,  that 
from  and  after  the  passage  of  this  Act,  any  national  banking  associa- 
tion which  has  been  in  business  for  one  year,  and  has  a  siu"plus  fund 
equal  to  twenty  per  centum  of  its  capital  maj'  take  out  for  issue  and 
circulation  national  bank  notes  without  a  deposit  of  United  States 
bonds  as  now  provided  by  law.  Said  notes  shall  be  known  as  "Na- 
tional Bank  Guaranteed  Credit  Notes."  Said  notes  shall  be  issued 
in  such  form  and  denominations,  and  under  such  rules  and  regula- 


APPENDIX  I  323 

tions  as  the  Comptroller  of  the  Currency  shall  fix.  The  amount  of 
said  notes  so  taken  out  by  any  national  banking  association  may  be 
equal  to  forty  per  centum  of  the  amount  of  its  national  bank  notes 
at  any  time  outstanding,  which  are  secured  by  the  deposit  of  govern- 
ment bonds,  but  shall  not  exceed  in  amount  twenty-five  per  centum 
of  its  capital;  provided,  however,  that  if  at  any  time  in  the  future  the 
present  proportion  of  the  total  outstanding  unmatured  United  States 
bonds  to  the  total  capitalization  of  all  national  banking  associations 
in  active  operation  shall  diminish,  then  the  authorized  issue  of  national 
bank  guaranteed  credit  notes  shall  be  increased  to  a  correspondingly 
greater  percentage  of  the  bond-secured  notes. 

Section  2.  That  every  national  banking  association  taking  out 
national  bank  guaranteed  credit  notes  in  accordance  with  the  fore- 
going section,  shall  pay  to  the  Treasurer  of  the  United  States  in  the 
months  of  January  and  July  a  tax  of  one  and  one-quarter  per  centum 
upon  the  average  amount  of  such  notes  in  circulation  during  the  pre- 
ceding half  year. 

Section  3.  That  any  national  banking  association  which  has 
taken  out  national  bank  guaranteed  credit  notes  in  accordance  with 
the  provisions  of  Section  1  of  this  Act,  may  take  out  a  further  amount 
of  national  bank  guaranteed  credit  notes  equal  to  twelve  and  one- 
half  per  centum  of  its  capital,  but  it  shall  pay  to  the  Treasurer  of  the 
United  States  in  the  months  of  January  and  July  a  tax  of  two  and 
one-half  per  centum  upon  the  average  amount  of  such  notes  in  cir- 
culation during  the  preceding  half  year. 

Section  4.  That  the  total  amount  of  bank  notes  issued  by  any 
national  banking  association,  including  national  bank  guaranteed 
credit  notes  taken  out  in  accordance  with  the  provisions  of  this  Act, 
shall  not  exceed  the  amount  of  its  paid-up  capital. 

Section  5.  That  any  national  banking  association  situated  and 
doing  business  in  a  Central  Reserve  City,  or  a  Reserve  City,  shall  at 
all  times  have  on  hand  in  lawful  money  of  the  United  States,  an  amount 
equal  to  at  least  twenty-five  per  centum  of  its  national  bank  guaranteed 
credit  notes  in  circulation;  and  every  other  national  banking  associa- 
tion shall  at  aU  times  have  on  hand  in  lawful  money  of  the  United 
States  an  amount  equal  to  at  least  fifteen  per  centum  of  its  guaranteed 
credit  notes  in  circulation;  provided,  however,  that  any  national 
banking  association  situated  and  doing  business  in  a  Reserve  City 
may  keep  one-half  of  its  lawful  money  reserve  on  deposit  in  a  national 
bank  in  a  Central  Reserve  City,  or  in  a  Reserve  City,  and  that  every 
national  banking  association  situated  and  doing  business  outside  of  a 
Central  Reserve  City,  or  a  Reserve  City,  may  keep  three-fifths  of  its 
lawful  money  reserve  on  deposit  m  a  national  bank  in  a  Central  Re- 
serve City,  or  in  a  Reserve  City. 


324  APPENDIX  I 

Section  6.  That  the  taxes  upon  national  bank  guaranteed  credit 
notes  provided  for  in  Sections  2  and  3  of  this  Act,  shall  be  paid  in 
lawful  money  to  the  Treasurer  of  the  United  States.  Said  taxes,  when 
received,  shall  constitute  a  guaranty  fund  to  redeem  the  notes  of  failed 
banks,  and  to  pay  the  cost  of  printing  and  current  redemption. 

Section  7.  That  when  any  national  banking  association  takes  out 
any  national  bank  guaranteed  credit  notes  for  issue  and  circulation, 
it  shall  deposit  with  the  Treasurer  of  the  United  States  in  lawful 
money  an  amount  equal  to  five  per  centum  thereof.  The  amount  so 
deposited  shall  be  placed  in  the  guaranty  fund  for  the  purposes  thereof. 
But  said  amount  shall  be  refunded  to  the  respective  banks  as  soon  as 
the  taxes  provided  for  in  Sections  2  and  3  of  this  Act  maintain  said 
guaranty  fund  above  five  per  centum  of  the  maximum  amount  of  na- 
tional bank  guaranteed  credit  notes  taken  out  for  issue  and  circula- 
tion, but  that  no  bank  .shall  withdraw  any  part  of  its  deposit  of  said 
five  per  centiim  until  it  shall  have  to  it.s  credit  in  said  fund  more  than 
five  per  centum. 

Section  8.  That  the  Comptroller  of  the  Currency  shall  designate 
certain  cities  conveniently  located  in  the  various  sections  of  the  United 
States  for  the  current  daily  re<lemi)tion  (»f  sjiiil  national  bank  gviar- 
anteed  credit  notes;  he  shall  fix  rules  and  regulations  for  such  re- 
demption; and,  before  authorizing  and  permitting  any  national  bank- 
ing association  to  take  out  for  issue  and  circulation  any  national  bank 
guaranteed  credit  notes,  he  shall  require  such  bank  to  make  arrange- 
ments satisfactory  to  him  for  the  current  daily  redemption  of  such 
notes  in  every  redemption  city  so  designated. 

Section  9.  That  said  national  bunk  guaranteed  credit  notes, 
issued  in  accordance  with  the  provisions  of  this  .\et  shall  be  received 
at  par  in  all  parts  of  the  United  States  in  payment  of  taxes,  excises, 
public  lands,  and  all  other  dues  to  the  United  States,  except  duties  on 
imports;  and  also  for  all  salaries  and  other  debts  and  demands  owing 
by  the  United  States  to  individuals,  corporations,  and  associations 
within  the  United  States  except  interest  on  public  debt  and  in  redemp- 
tion of  tlie  national  currency.  Said  notes  shall  be  received  upon  de- 
posit and  for  all  purposes  of  debt  and  liability  by  every  national  bank- 
ing association  at  par  and  without  charge  of  whatsoever  kind. 

Section  10.  That  the  holder  of  any  national  bank  guaranteed 
credit  note  shall  have  a  prior  lien  on  the  assets  of  the  national  banking 
association  issuing  it  and  on  the  statutory  liability  of  shareholders. 

Section  11.  That  upon  tlie  failure  of  a  national  banking  associa- 
tion, all  outstanding  national  bank  guaranteed  credit  notes  taken  out 
by  it  in  accordance  with  the  provisions  of  this  .\ct,  shall  upon  presen- 
tation to  the  United  States  Treasurer  be  paid  in  lawful  money  out  of 
the  guaranty  fund;   but  the  United  States  Treasurer  shall  recover  in 


APPENDIX  I  325 

lawful  money  from  the  assets  of  the  failed  bank  the  amount  of  the 
guaranteed  credit  notes  of  such  bank  outstanding  at  the  time  of  failure, 
and  the  same  shall  be  paid  into  the  guaranty  fund  as  provided  in  Sec- 
tion 10  of  this  Act. 

Section  12.  That  any  national  banking  association  desiring  to 
retire  its  national  bank  guaranteed  credit  notes  or  to  go  into  liquida- 
tion shall  pay  into  the  guaranty  fund  an  amount  of  lawful  money 
equal  to  the  amount  of  its  national  bank  guaranteed  credit  notes  then 
outstanding. 

Section  13,  Tliat  any  national  banking  association  desiring  to 
take  out  national  bank  guaranteed  credit  notes  and  having  notes  out- 
standing in  excess  of  sixty-two  and  one-half  per  centum  of  its  paid-up 
capital,  to  secure  the  payment  of  which  United  States  bonds  have 
been  deposited,  may,  upon  the  deposit  of  lawful  money,  redeem  such 
excess  without  reference  to  the  limitation  of  nine  million  dollars  each 
month  prescribed  in  the  Act  approved  March  fourth,  nineteen  hundred 
and  seven. 


APPENDIX  II 

PLAN  OF  THE  NATIONAL  MONETARY 
COMMISSION  1 

A  BILL 

To  Incorporate  the  National  Reserve  Association  of  the 
United  States,  and  for  Other  Purposes 

Be  it  enacted  by  the  Senate  and  House  of  Representatives  of  the  United 
States  of  America  in  Congress  assembled,  That  the  National  Reserve 
Association  of  the  United  States  be,  and  it  is  hereby,  created  and 
estabHshed  for  a  term  of  fifty  years  from  the  date  of  filing  with  the 
Comptroller  of  the  Currency  a  certificate  of  paid-in  capital  stock  as 
hereinafter  provided.  It  shall  have  an  authorized  capital  equal  in 
amount  to  twenty  per  centum  of  the  paid-in  and  unimpaired  capital 
of  all  banks  eligible  for  membership  in  said  National  Reserve  Asso- 
ciation, Before  said  association  shall  be  authorized  to  commence 
business  two  hundred  million  dollars  of  the  capital  stock  shall  be  sub- 
scribed and  one  hundred  million  dollars  of  its  capital  shall  be  paid  in 
cash.  The  capital  stock  of  said  association  shall  be  divided  into  shares 
of  one  hundred  dollars  each.  The  outstanding  capital  stock  may  be 
increased  from  time  to  time  as  subscribing  banks  increase  their  capital 
or  as  additional  banks  become  subscribers  or  may  be  decreased  as 
subscribing  banks  reduce  their  capital  or  leave  the  association  by 
liquidation.  The  head  oflBce  of  the  National  Reserve  Association 
shall  be  located  in  'Washington,  in  the  District  of  Columbia. 

Sec.  2.  Upon  duly  making  and  filing  with  the  Comptroller  of  the 
Currency  the  certificate  hereinafter  required  the  National  Reserve 
Association  of  the  United  States  shall  become  a  body  corporate  and 
as  such  and  by  that  name  shall  have  p>ower — 

First.     To  adopt  and  use  a  corporate  seal. 

Second.  To  have  succession  for  a  period  of  fifty  years  from  the 
date  of  said  certificate. 

Third.  To  make  all  contracts  necessary  and  proper  to  carry  out 
the  purposes  of  this  act. 

*  The  first  tentative  plan  was  proposed  by  the  chairman,  Senator  Aldrich, 
January  16,  1911;  a  re\'iscd  outline,  October  14,  1911;  and  the  final  plan  with 
a  report  was  laid  before  Congress  January  8,  1912. 

326 


APPENDIX  II  327 

Fourth.  To  sue  and  be  sued,  complain  and  defend,  in  any  court  of 
law  or  equity,  as  fully  as  natural  persons. 

Fifth.  To  elect  or  appoint  directors  and  officers  in  the  manner 
hereinafter  provided  and  define  their  duties. 

Sixth.  To  adopt  by  its  board  of  directors  by-laws  not  inconsistent 
with  this  act,  regulatmg  the  manner  in  which  its  property  shall  be 
transferred,  its  general  business  conducted,  and  the  privileges  granted 
to  it  by  law  exercised  and  enjoyed. 

Seventh.  To  purchase,  acquire,  hold,  and  convey  real  estate  as 
hereinafter  provided. 

Eighth.  To  exercise  by  its  board  of  directors  or  duly  authorized 
committees,  officers,  or  agent,  subject  to  law,  all  the  powers  and  priv- 
ileges conferred  upon  the  National  Reserve  Association  by  the  act. 

Sec.  8.  All  national  banks,  and  all  banks  or  trust  companies  char- 
tered by  the  laws  of  any  State  of  the  United  States  or  of  the  District 
of  Columbia,  complying  with  the  requirements  for  membership  in 
the  said  National  Reserve  Association,  hereinafter  set  forth,  may  sub- 
scribe to  its  capital  to  an  amount  equal  to  twenty  per  centum  of  the 
paid-in  and  unimpaired  capital  of  the  subscribing  bank,  and  not  more 
nor  less;  and  each  of  such  subscribing  banks  shall  become  a  member 
of  a  local  association  as  hereinafter  provided.  Fifty  per  centum  of  the 
subscriptions  to  the  capital  stock  of  the  National  Reserve  Association 
shall  be  fully  paid  in;  the  remainder  of  the  subscriptions  or  any  part 
thereof  shall  become  a  liability  of  the  subscribers,  subject  to  call  and 
payment  thereof  whenever  necessary  to  meet  the  obligations  of  the 
National  Reserve  Association  under  such  terms  and  in  accordance 
with  such  regulations  as  the  board  of  directors  of  the  National  Reserve 
Association  may  prescribe. 

The  subscriptions  of  a  bank  or  trust  company  incorporated  under 
the  laws  of  any  State  or  of  the  District  of  Columbia  to  the  capital 
stock  of  the  National  Reserve  Association  shall  be  made  subject  to  the 
following  conditions: 

First.  That  (a)  if  a  bank,  it  shall  have  a  paid-in  and  unimpaired 
capital  of  not  less  than  that  required  for  a  national  bank  in  the  same 
locality;  and  that  (b)  if  a  trust  company,  it  shall  have  an  unimpaired 
surplus  of  not  less  than  twenty  per  centum  of  its  capital,  and  if  located 
in  a  place  having  a  population  of  six  thousand  inhabitants  or  less  shall 
have  a  paid-in  and  unimpaired  capital  of  not  less  than  fifty  thousand 
dollars;  if  located  in  a  city  having  a  population  of  more  than  six 
thousand  inhabitants  and  not  more  than  fifty  thousand  inhabitants, 
shall  have  a  paid-in  and  unimpaired  capital  of  not  less  than  one  hun- 
dred thousand  dollars;  if  located  in  a  city  having  a  population  of  more 
than  fifty  thousand  inhabitants  and  not  more  than  two  hundred  thou- 
sand inhabitants  shall  have  a  paid-in  and  unimpaired  capital  of  not 


328  APPENDIX  II 

less  than  two  hundred  thousand  dollars;  if  located  in  a  city  having  a 
population  of  more  than  two  hundred  thousand  inhabitants  and  not 
more  than  three  hundred  thousand  inhabitants  shall  have  a  paid-in 
and  unimpaired  capital  of  not  less  than  three  hundred  thousand  dol- 
lars; if  located  in  a  city  having  a  population  of  more  than  three  hun- 
dred thousand  inhabitants  and  not  more  than  four  hundred  thousand 
inhabitants  shall  have  a  paid-in  and  unimpaired  capital  of  not  less 
than  four  hundred  thousand  dollars,  and  if  located  in  a  city  having  a 
population  of  more  than  four  hundred  thousand  inliabitants  shall  have 
a  paid-in  and  unimpaired  capital  of  not  less  than  five  hundred  thou- 
sand dollars. 

Second.  That  it  shall  have  and  agree  to  maintain  against  its  de- 
mand deposits  a  reserve  of  like  cliaracter  and  proportion  to  that  re- 
quired by  law  of  a  national  bank  in  the  same  locality:  Provided,  how- 
ever. That  deposits  which  it  may  have  with  any  subscribing  national 
bank.  State  bank,  or  trust  company  in  a  city  designated  in  the  national 
banking  laws  as  a  reserve  city  or  a  central  resers'e  city  shall  count  aa 
reserve  in  like  manner  and  to  the  same  extent  as  similar  deposits  of  a 
national  bank  with  national  banks  in  such  cities. 

Third.  That  it  shall  have  and  agree  to  maintain  against  other 
classes  of  deposits  the  percentages  of  reserve  required  by  this  act. 

Fourth.  That  it  shall  agree  to  submit  to  such  examinations  and  to 
make  such  repwrts  as  are  required  by  law  and  to  comply  with  the  re- 
quirements and  conditions  imposed  by  this  act  and  regulations  made 
in  conformity  therewith. 

The  words  "subscribing  banks"  when  used  hereafter  in  this  act 
shall  be  understood  to  refer  to  such  national  banks,  and  banks  or 
trust  companies  chartered  by  the  laws  of  any  State  of  the  United 
States  or  of  the  District  of  Columbia,  as  shall  comply  with  the  re- 
quirements for  membership  herein  defined. 

Sec.  4.  The  Secretary  of  tlie  Treasury,  the  Secretary  of  Agricul- 
ture, the  Secretary  of  Commerce  and  Labor,  and  the  Comptroller  of 
the  Currency  are  hereby  designated  a  committee  to  effect  the  organi- 
zation of  the  National  Reserve  Association,  and  the  necesi>ary  expenses 
of  said  committee  shall  be  payable  out  of  the  Treasury  upon  vouchers 
approved  by  the  members  of  said  committee,  and  the  Treasury  shall 
be  reimbursed  by  the  National  Reserve  Association  to  the  full  amount 
paid  out  therefor. 

Within  sixty  days  after  the  passage  of  tliis  act  said  committee  shall 
provide  for  the  opening  of  books  for  subscriptioas  to  the  capital  stock 
of  said  National  Reserve  Association  in  such  places  as  the  said  com- 
mittee may  designate.  Before  the  subscription  of  any  bank  to  the 
capital  stock  of  the  National  Reserve  Association  shall  be  accepted, 
said  bank  shall  file  with  the  organization  committee  or  after  organiza- 


APPENDIX  II  329 

tion  with  the  National  Reserve  Association  a  certified  copy  of  a  reso- 
lution adopted  by  the  board  of  directors  of  said  bank  accepting  all  the 
provisions  and  liabilities  imposed  by  this  act  and  authorizing  the  presi- 
dent or  cashier  of  said  bank  to  subscribe  for  said  stock. 

Sec.  5.  When  the  subscriptions  to  the  capital  stock  of  the  Na- 
tional Reserve  Association  shall  amount  to  the  sum  of  two  hundred 
million  dollars  the  organization  committee  hereinbefore  provided  shall 
forthwith  proceed  to  select  fifteen  cities  in  the  United  States  for  the 
location  of  the  branches  of  said  National  Reserve  Association:  Pro- 
vided, That  one  branch  sliall  be  located  in  the  New  England  States, 
including  the  States  of  Maine,  New  Hampshire,  Vermont,  Massa- 
chusetts, Rhode  Island,  and  Connecticut;  two  branches  in  the  East- 
ern States,  including  the  States  of  New  York,  New  Jersey,  Pennsyl- 
vania, and  Delaware;  four  branches  in  the  Southern  States,  including 
the  States  of  Maryland,  Virginia,  West  Virginia,  North  Carolina,  South 
Carolina,  Georgia,  Florida,  Alabama,  Mississippi,  Louisiana,  Texas, 
Arkansas,  Kentucky,  Tennessee,  and  also  the  District  of  Columbia; 
four  branches  in  the  Middle  Western  States,  including  the  States  of 
Ohio,  Indiana,  Illinois,  Michigan,  Wisconsin,  Minnesota,  Iowa,  and 
Missouri;  four  branches  in  the  Western  and  Pacific  States,  including 
the  States  of  North  Dakota,  South  Dakota,  Nebraska,  Kansas,  Mon- 
tana, Wyoming,  Colorado,  New  Mexico,  Oklahoma,  Washington, 
Oregon,  California,  Idaho,  Utah,  Nevada,  and  Arizona. 

Wlien  the  cities  in  which  the  branches  are  to  be  located  have  been 
selected  the  organization  committee  shall  forthwith  divide  the  entire 
country  into  fifteen  districts,  with  one  branch  of  the  National  Reserve 
Association  in  each  district:  Provided,  That  the  districts  shall  be  ap- 
portioned with  due  regard  to  the  convenient  and  customary  course  of 
business  and  not  necessarily  along  State  lines. 

The  districts  may  be  readjusted,  and  new  districts  and  new  branches 
may  from  time  to  time  be  created  by  the  directors  of  the  National 
Reserve  Association  whenever,  in  their  opmion,  the  business  of  the 
country  requires. 

Sec.  6.  All  subscribing  banks  within  a  district  shall  be  grouped 
by  the  organization  committee  or  after  organization,  by  the  National 
Reserve  Association,  into  local  associations  of  not  less  than  ten  banks, 
with  an  aggregate  capital  and  surplus  of  at  least  five  million  dollars, 
for  the  purposes  hereinafter  prescribed:  Provided,  That  the  territory 
included  in  each  association  shall  be  contiguous  and  that  in  appor- 
tioning the  territory  due  regard  shall  be  had  for  the  customary  course 
of  business  and  for  the  convenience  of  the  banks  forming  the  associa- 
tion: Provided  further,  That  in  apportioning  the  territory  to  local  asso- 
ciations comprising  a  district  every  bank  and  all  of  the  territory  within 
said  district  shall  be  located  within  the  boundaries  of  some  local  asso- 


330  APPENDIX  II 

ciation :  And  provided  further,  That  every  subscribing  bank  shall  be- 
come a  member  only  of  the  local  association  of  the  territory  in  which 
it  is  situated. 

The  banks  uniting  to  form  a  local  association  shall,  by  their  presi- 
dents or  vice  presidents,  under  authority  from  the  board  of  directors, 
execute  a  certificate  in  triplicate  setting  forth  the  name  of  the  associa- 
tion, the  names  of  the  banks  comjwsing  it,  its  principal  place  of  busi- 
ness, its  territorial  limits,  and  the  purposes  for  which  it  is  organized. 
One  copy  of  this  certificate  shall  be  filed  with  the  Comptroller  of  the 
Currency,  one  copy  shall  be  filed  with  the  National  Reserve  Associa- 
tion, and  one  copy  shall  be  filed  with  the  branch  of  the  National  Re- 
serve Association  of  the  district  in  which  the  local  association  is  in- 
cluded. Upon  the  filing  of  such  certificates  the  local  association 
therein  named  shall  become  a  body  corporate  and  by  the  name  so 
designated  may  sue  and  be  sued  and  exercise  the  powers  of  a  body 
corporate  for  the  purposes  mentioned  in  this  act,  and  not  otherwise. 

The  local  associations  in  each  district  may  be  readjusted  from  time 
to  time  and  new  associations  may  be  authorized  by  the  directors  of 
the  National  Reserve  Association. 

Sec.  7.  Each  local  association  shall  have  a  board  of  directors,  the 
number  to  be  determined  by  the  by-laws  of  the  local  association. 
Three-fifths  of  that  number  shall  be  elected  by  ballot  cast  by  the  rep- 
resentatives of  the  banks  that  are  members  of  the  local  association, 
each  bank  having  one  representative  and  each  representative  one  vote 
for  each  of  the  positions  to  be  filled  without  reference  to  the  number 
of  shares  which  the  bank  holds  in  the  National  Reserve  Association. 
Two-fiftlis  of  the  whole  number  of  directors  of  the  local  association 
shall  be  elected  by  the  same  representatives  of  the  several  banks  that 
are  members  of  the  association,  but  in  voting  for  these  additional  di- 
rectors each  representative  shall  be  entitled  to  as  many  votes  as  the 
bank  which  he  represents  'holds  shares  in  the  National  Reserve  Asso- 
ciation: Provided,  That  in  case  forty  per  centum  of  the  capital  stock 
in  any  subscribing  bank  is  owned  directly  or  indirectly  by  any  other 
subscribing  bank,  or  in  case  forty  per  centum  of  the  capital  stock  in 
each  of  two  or  more  subscribing  banks,  being  members  of  the  same 
local  association,  is  owned  directly  or  indirectly  by  the  same  person, 
persons,  copartnership,  voluntary  association,  trustee,  or  corporation, 
then  and  in  either  of  such  cases,  neither  of  such  banks  shall  be  entitled 
to  vote  separately,  as  a  unit,  or  upon  its  stock,  except  that  such  banks 
acting  together,  as  one  unit,  shall  be  entitled  to  one  vote,  for  the  elec- 
tion of  the  board  of  directors  of  such  local  association.  In  no  case 
shall  voting  by  proxy  be  allowed.  The  authorized  representiitive  of  a 
bank,  as  herein  provided,  shall  be  its  president,  vice  president,  or 
cashier. 


APPENDIX  II  331 

Each  director  shall  take  an  oath  that  he  will,  so  far  as  the  duty 
devolves  upon  him,  diligently  and  honestly  administer  the  affairs  of 
such  association  and  will  not  knowingly  violate  or  willingly  permit  to 
be  violated  any  of  the  provisions  of  this  act. 

The  directors  originally  elected  shall  hold  oflSce  imtil  the  second 
Tuesday  in  February  immediately  following  their  election,  and  there- 
after the  directors  shall  be  elected  annually  on  that  date  and  shall 
hold  oflBce  for  the  term  of  one  year. 

The  board  of  directors  of  the  local  association  shall  have  authority 
to  make  by-laws,  not  inconsistent  with  law,  which  shall  be  subject  to 
the  approval  of  the  National  Reserve  Association. 

Sec.  8.  Each  of  the  branches  of  the  National  Reserve  Association 
shall  have  a  board  of  directors,  the  number,  not  less  than  twelve  in 
addition  to  the  ex  officio  member,  to  be  fixed  by  the  by-laws  of  the 
branch.     These  directors  shall  be  elected  in  the  following  manner: 

The  board  of  directors  of  each  local  association  shall  elect  by  ballot^ 
a  voting  representative.  One-half  of  the  elected  directors  of  the 
branch  shall  be  elected  by  the  vote  of  such  representatives,  each  rep- 
resentative having  one  vote  for  each  of  the  positions  to  be  filled, 
without  reference  to  the  number  of  shares  which  the  banks  composing 
the  association  which  he  represents  holds  in  the  National  Reserve 
Association.  One-third  of  the  elected  directors  shall  be  elected  by 
the  same  voting  representatives,  but  each  voting  representative  in 
this  case  shall  have  a  number  of  votes  equal  to  the  number  of  shares 
in  the  National  Reserve  Association  held  by  all  the  banks  composing 
the  local  association  which  he  represents.  The  remaining  one-sixth 
of  the  directors  shall  be  chosen  by  the  directors  already  elected  and 
shall  fairly  represent  the  agricultural,  commercial,  mdustrial,  and  other 
interests  of  the  district  and  shall  not  be  officers  nor,  while  serving, 
directors  of  banks,  trust  companies,  insurance  companies,  or  other 
financial  institutions.  The  manager  of  the  branch  shall  be  ex  officio 
a  member  of  the  board  of  directors  of  the  branch  and  shall  be  chair- 
man of  the  board. 

Each  director  shall  take  an  oath  that  he  will,  so  far  as  the  duty  de- 
volves upon  him,  diligently  and  honestly  administer  the  affairs  of 
such  association  and  will  not  knowingly  violate  or  willingly  permit  to 
be  violated  any  of  the  provisions  of  this  act. 

All  the  members  of  the  board  of  directors  of  the  branch  except  the 
ex  officio  member  shall  at  the  first  meeting  of  the  board  be  divided 
into  three  classes.  One-third  of  the  directors  shall  hold  office  until 
the  first  Tuesday  in  March  immediately  following  the  election;  one- 
third  of  the  directors  shall  hold  office  for  an  additional  period  of  one 
year  after  the  first  Tuesday  in  March  immediately  following  the  elec- 
tion;  the  remaining  one- third  of  the  directors  shall  hold  office  for  an 


332  APPENDIX  II 

additional  period  of  two  years  after  the  first  Tuesday  in  March  im- 
mediately following  the  election.  All  elections  shall  be  held  on  the 
first  Tuesday  in  March  of  each  year,  and  after  the  first  election  all 
directors  shall  be  elected  for  a  term  of  three  years :  Provided,  That  the 
by-laws  of  the  National  Reserve  Association  shall  provide  for  the  man- 
ner of  filling  any  vacancies  which  may  occur  in  the  board  of  directors 
of  the  branches. 

The  board  of  directors  of  the  branch  shall  have  authority  to  make 
by-laws,  not  inconsistent  with  law,  which  shall  be  subject  to  the  ap- 
proval of  the  National  Reserve  Association. 

Sec.  9.  The  National  Reserve  Association  shall  have  a  board  of 
directors,  to  be  chosen  in  the  following  manner: 

First.  Fifteen  directors  shall  be  elected,  one  by  the  board  of  di- 
rectors of  each  branch  of  the  National  Reserve  Association.  In  case 
the  number  of  districts  shall  be  increased  hereafter,  each  additional 
district  shall  be  entitled  to  elect  an  additional  director  of  this  class. 

Second.  Fifteen  additional  directors  shall  be  elected,  one  by  the 
board  of  directors  of  each  branch  of  the  National  Reserve  Association, 
who  shall  fairly  represent  the  agricultural,  commercial,  industrial,  and 
other  interests  of  the  district,  and  who  shall  not  be  oflScers  nor,  while 
serving,  directors  of  banks,  trust  companies,  insurance  companies,  or 
other  financial  institutions.  In  case  the  number  of  districts  shall  be 
increased  hereafter,  each  additional  district  shall  be  entitled  to  elect 
an  additional  director  of  this  class. 

Third.  Nine  additional  directors  shall  be  elected  by  voting  rep- 
resentatives chosen  by  the  boards  of  directors  of  the  various  branches, 
each  of  whom  shall  cast  a  number  of  votes  equal  to  the  number  of 
shares  in  the  National  Reserve  Association  held  by  the  banks  in  the 
branch  which  he  represents.  Nyt  more  than  one  of  the  directors  of 
this  class  shall  be  chosen  from  one  district.  Directors  of  each  of  the 
three  classes  named  above  shall  be  residents  of  the  district  from  which 
they  are  elected. 

Fourth.  There  shall  be  seven  ex  officio  members  of  the  board  of 
directors,  namely:  The  governor  of  the  National  Reserve  Associa- 
tion, who  shall  be  chairman  of  the  board,  two  deputy  governors  of 
the  National  Reserve  Association,  the  Secretary  of  the  Treasury,  the 
Secretary  of  Agriculture,  the  Secretary  of  Commerce  and  Labor,  and 
the  Comptroller  of  the  Currency. 

No  member  of  any  national  or  State  legislative  body  shall  be  a  di- 
rector of  the  National  Reserve  Association,  nor  of  any  of  its  branches, 
nor  of  any  local  association. 

All  the  members  of  the  board,  except  the  ex  oflBcio  members,  shall 
at  the  first  meeting  of  the  board  be  divided  into  three  classes.  One- 
third  of  the  directors  shall  hold  oflBce  until  the  first  Tuesday  in  April 


APPENDIX  II  333 

immediately  following  the  election;  one- third  of  the  directors  shall 
hold  oflBce  for  an  additional  period  of  one  year  after  the  first  Tuesday 
in  April  immediately  following  the  election;  the  remaining  one-third 
of  the  directors  shall  hold  oflace  for  an  additional  period  of  two  years 
after  the  first  Tuesday  in  April  immediately  following  the  election. 
All  elections  shall  be  held  on  the  first  Tuesday  in  April  of  each  year, 
and  after  the  first  election  all  directors  shall  be  elected  for  a  term  of 
three  years:  Provided,  That  all  directors  provided  for  in  sections  seven, 
eight,  and  nine  of  this  Act  shall  serve  until  their  successors  have  quali- 
fied: And  provided  further.  That  the  by-laws  of  the  National  Reserve 
Association  shall  provide  for  the  manner  of  filling  any  vacancies  which 
may  occur  in  the  board  of  directors  of  the  National  Reserve  Associa- 
tion. 

Each  director  shall  take  an  oath  that  he  will,  so  far  as  the  duty 
devolves  upon  him,  diligently  and  honestly  administer  the  affairs  of 
such  association  and  will  not  knowingly  violate  or  willingly  permit  to 
be  violated  any  of  the  provisions  of  this  act. 

The  board  of  directors  of  the  National  Reserve  Association  shall 
have  authority  to  make  by-laws,  not  inconsistent  with  law,  which 
shall  prescribe  the  manner  in  which  the  business  of  said  association 
shall  be  conducted  and  the  privileges  granted  to  it  by  law  exercised 
and  enjoyed. 

Sec.  10.  The  executive  oflficers  of  the  National  Reserve  Associa- 
tion shall  consist  of  a  governor,  two  deputy  governors,  a  secretary, 
and  such  subordinate  officers  as  may  be  provided  by  the  by-laws. 
The  governor  of  the  National  Reserve  Association  shall  be  selected  by 
the  President  of  the  United  States  from  a  list  of  not  less  than  three 
submitted  to  him  by  the  board  of  directors  of  said  association.  The 
person  so  selected  shall  thereupon  be  appointed  by  the  said  board  as 
governor  of  the  National  Reserve  Association  for  a  term  of  ten  years, 
subject  to  removal  for  cause  by  a  two-thirds  vote  of  the  board.  There 
shall  be  two  deputy  governors,  to  be  elected  by  the  board,  for  a  term 
of  seven  years,  subject  to  removal  for  cause  by  a  majority  vote  of  the 
board.  The  two  deputy  governors  first  elected  shall  serve  for  terms 
of  four  years  and  seven  years,  respectively.  In  case  of  any  vacancy 
in  the  office  of  deputy  governor  his  successor  shall  be  elected  to  fill 
the  imexpired  term.  In  the  absence  of  the  governor  or  his  inability 
to  act  the  deputy  who  is  senior  in  point  of  service  shall  act  as  governor. 
The  board  of  directors  shall  have  authority  to  appoint  such  other 
officers  as  may  be  provided  for  by  the  by-laws. 

Sec.  11.  When  the  National  Reserve  Association  is  duly  organized 
its  board  of  directors  shall  call  upon  the  subscribing  banks  for  a  pay- 
ment of  fifty  per  centum  on  the  amount  of  their  subscriptions  to  the 
capital  stock  of  said  association.     When  one  hundred  million  dollars 


334  APPENDIX  II 

of  capital  have  been  paid  in  the  board  of  directors  shall  at  once  pro- 
ceed to  execute  and  file  with  the  Secretary  of  State  a  certificate  show- 
ing the  payment  of  one  hundred  million  dollars  on  capital  stock,  and 
they  shall  further  file  with  the  Comptroller  of  the  Currency  a  certificate 
showing  the  title  and  location  of  each  bank  which  has  subscribed  to 
the  capital  stock  of  the  National  Reserve  Association,  the  number  of 
shares  subscribed  by  each,  and  the  amount  paid  thereon. 

Sec,  12.  Shares  of  the  capital  stock  of  the  National  Reserve  Asso- 
ciation shall  not  be  transferable,  and  under  no  circumstances  shall 
they  be  hj'pothecated  nor  shall  they  be  owned  otherwise  than  by 
subscribing  banks,  nor  shall  they  be  owned  by  any  such  bank  other 
than  in  the  proportion  herein  provided.  In  case  a  subscribing  bank 
increases  its  capital  it  shall  thereupon  subscribe  for  an  additional 
amount  of  the  capital  of  the  National  Reserve  Association  equal  to 
twenty  per  centum  of  the  bank's  increase  of  capital,  paying  therefor 
its  then  book  value  as  shown  by  the  last  published  statement  of  said 
association.  A  bank  applying  for  membership  in  the  National  Re- 
serve Association  at  any  time  after  its  formation  must  subscribe  for 
an  amount  of  the  capital  of  said  association  equal  to  twenty  per  cen- 
tum of  the  capital  of  said  subscribing  bank,  paying  therefor  its  then 
book  value  as  shown  by  the  last  published  statement  of  said  associa- 
tion. When  the  capital  of  the  National  Reserve  Association  has  been 
increased  either  on  account  of  the  increase  of  capital  of  the  banks  in 
said  association  or  on  account  of  the  increase  in  the  membership  of 
said  association,  the  board  of  directors  shall  make  and  execute  a  cer- 
tificate showing  said  increase  in  capital,  the  amount  paid  in  and  by 
whom  paid.  This  certificate  shall  be  filed  in  the  ofiice  of  the  Comp- 
troller of  the  Currency.  In  case  a  subscribing  bank  reduces  its  cap- 
ital it  shall  surrender  a  proportionate  amount  of  its  holdings  in  the 
capital  of  said  association,  and  if  a  bank  goes  into  voluntary  liquida- 
tion it  shall  surrender  all  of  its  holdings  of  the  capital  of  said  associa- 
tion. In  either  case  the  shares  surrendered  shall  be  canceled  and  the 
bank  shall  receive  in  payment  therefor  a  sum  equal  to  their  then  book 
value  as  shown  by  the  last  published  statement  of  said  association. 

If  any  member  of  the  National  Reserve  Association  shall  become 
insolvent  and  a  receiver  be  appointed,  the  stock  held  by  it  in  said  asso- 
ciation shall  be  canceled  ^nd  the  balance,  after  paying  all  debts  due 
by  such  insolvent  bank  to  said  association  (such  debts  being  hereby 
declared  to  be  a  first  lien  upon  the  paid-in  capital  stock),  shall  be 
paid  to  the  receiver  of  the  insolvent  bank. 

Whenever  the  capital  stock  of  the  National  Reserve  Association  is 
reduced,  either  on  account  of  the  reduction  in  capital  of  members  of 
said  association  or  the  liquidation  or  insolvency  of  any  member,  the 
board  of  directors  shall  make  and  execute  a  certificate  showing  such 


APPENDIX  II  335 

reduction  of  capital  stock  and  the  amount  repaid  to  each  bank.  This 
certificate  shall  be  filed  in  the  oflace  of  the  Comptroller  of  the  Cur- 
rency. 

Sec.  13.  The  National  Reserve  Association  and  its  branches  and 
the  local  associations  shall  be  exempt  from  local  and  State  taxation 
except  in  respect  to  taxes  upon  real  estate. 

Sec.  14.  The  directors  of  the  National  Reserve  Association  shall 
annually  elect  from  their  number  an  executive  committee  and  such 
other  committees  as  the  by-laws  of  the  National  Reserve  Association 
may  provide.  The  executive  committee  shall  consist  of  nine  members, 
of  which  the  governor  of  the  National  Reserve  Association  shall  be 
ex  oflScio  chairman  and  the  two  deputy  governors  and  the  Comptroller 
of  the  Currency  ex  oflBcio  members,  but  not  more  than  one  of  the 
elected  members  shall  be  chosen  from  any  one  district. 

The  executive  committee  shall  have  all  the  authority  which  is  vested 
in  the  board  of  directors,  except  the  power  of  nomination,  appoint- 
ment, and  removal  of  the  governor  and  deputy  governors  and  except 
such  as  may  be  sp>ectfically  delegated  by  the  board  to  other  com- 
mittees or  to  the  executive  officers,  or  such  as  may  be  specifically  re- 
served or  retained  by  the  board. 

Sec.  15.  There  shall  be  a  board  of  examination  elected  annually 
by  the  board  of  directors  from  among  their  number,  excluding  the 
members  of  the  executive  committee,  of  which  the  Secretary  of  the 
Treasury  shall  be  ex  officio  chairman.  It  shall  be  the  duty  of  this 
board  to  carefully  examiue  the  condition  and  the  business  of  the 
National  Reserve  Association  and  of  its  branches  and  to  make  a  public 
statement  of  the  result  of  such  examination  at  least  once  a  year. 

Sec.  16.  Each  branch  shall  have  a  manager  and  a  deputy  manager 
appointed  from  the  district  by  the  governor  of  the  National  Reserve 
Association  with  the  approval  of  the  executive  committee  of  said  asso- 
ciation and  the  board  of  directors  of  the  branch,  and  subject  to  re- 
moval at  any  time  by  the  governor  with  the  approval  of  the  executive 
committee  of  the  National  Reserve  Association.  The  powers  and 
duties  of  the  manager  and  deputy  manager  and  of  the  various  com- 
mittees of  the  branches  shall  be  prescribed  by  the  by-laws  of  the  Na- 
tional Reserve  Association. 

Sec.  17.  The  directors  of  each  local  association  shall  annually 
elect  from  their  number  a  president,  a  vice  president,  and  an  execu- 
tive committee,  whose  powers  and  duties  shall  be  determined  by  the 
by-laws  of  the  local  association,  subject,  however,  to  the  approval  of 
the  National  Reserve  Association. 

Sec.  18.  The  National  Reserve  Association  shall  cause  to  be  kept 
at  all  times,  at  the  head  office  of  the  association,  a  full  and  correct  list 
of  the  names  of  the  banks  owning  stock  in  the  association  and  the  num- 


336  APPENDIX  II 

ber  of  shares  held  by  each.  Such  list  shall  be  subject  to  the  insj>ection 
of  all  the  shareholders  of  the  association,  and  a  copy  thereof  on  the 
first  Monday  of  July  of  each  year  shall  be  transmitted  to  the  Comp- 
troller of  the  Currency. 

Sec.  19.  The  earnings  of  the  National  Reserve  Association  shall 
be  disposed  of  in  the  following  manner: 

After  the  payment  of  all  expenses  and  the  franchise  and  other  taxes 
not  provided  for  in  this  section  the  shareholders  shall  be  entitled  to 
receive  an  annual  dividend  of  four  per  centum  on  the  paid-in  capital, 
which  dividend  shall  be  cumulative.  Further  annual  net  earnings 
shall  be  disposed  of  as  follows:  First,  a  contingent  fund  shall  be  cre- 
ated, which  shall  be  maintained  at  an  amount  equal  to  one  per  cen- 
tum on  the  paid-in  capital,  and  shall  not  exceed  in  any  event  two 
million  dollars  and  shall  be  used  to  meet  any  possible  losses.  Such 
fund  shall,  upon  the  final  dissolution  of  the  National  Reserve  Associa- 
tion, be  paid  to  the  United  States  and  shall  not  under  any  circum- 
stances be  included  in  the  book  value  of  the  stock  or  be  paid  to  the 
shareholders.  Second,  one-half  of  additional  net  earnings  shall  be 
paid  into  the  surplus  fund  of  the  National  Reserve  Association  imtil 
said  fund  shaU  amount  to  twenty  per  centum  of  the  paid-in  capital, 
one-fourth  shall  be  paid  to  the  United  States  as  a  franchise  tax,  and 
one-fourth  shall  be  paid  to  the  shareholders,  until  the  shareholders* 
dividend  shall  amount  to  five  per  centum  per  annum  on  the  paid-in 
capital:  Provided,  That  no  such  dividends,  exclusive  of  the  cumulative 
dividends  above  provided  for,  shall  at  any  time  be  paid  in  excess  of 
five  per  centum  in  any  one  year.  Whenever  and  so  long  as  the  con- 
tingent fund  has  been  provided  for  and  the  five  per  centum  dividend 
has  been  paid  to  shareholders  one-half  of  the  additional  earnings  shall 
be  added  to  the  surplus  fund,  and  one-half  shall  be  paid  to  the  United 
States  as  a  franchise  tax.  Whenever  and  so  long  as  the  surplus  fund 
of  the  National  Reserve  Association  amounts  to  twenty  per  centum 
of  the  paid-in  capital  and  the  shareholders  shall  have  received  divi- 
dends not  exceeding  five  per  centum,  all  excess  earnings  shrll  be  paid 
to  the  United  States  as  a  franchise  tax. 

Sec.  20.  Any  member  of  a  local  association  may  apj-ly  to  such 
association  for  a  guaranty  of  the  commercial  paper  -^  liich  it  desires 
to  rediscount  at  the  branch  of  the  National  Reserve  Association  in  its 
district.  Any  such  bank  receivmg  a  guaranty  from  a  local  association 
shall  pay  a  commission  to  the  local  association,  to  be  fixed  in  each  case 
by  its  board  of  directors.  Expenses  and  losses  in  excess  of  commis- 
sions shall  be  met  by  an  assessment  of  the  raembers  of  the  local  asso- 
ciation in  proportion  to  the  ratio  which  their  capital  and  surplus  bears 
to  the  aggregate  capital  and  surplus  of  the  members  of  the  local  asso- 
ciation, which  assessment  shall  be  made  by  its  board  of  directors,  and 


APPENDIX  II  337 

the  commission  received  for  such  guaranty,  after  the  payment  of  ex- 
penses and  possible  losses,  shall  be  distributed  among  the  several  banks 
of  the  local  association  in  the  same  proportion.  A  local  association 
shall  have  authority  to  require  security  from  any  bank  offering  paper 
for  guaranty,  or  it  may  decline  to  grant  the  application.  The  total 
amount  of  guaranties  by  a  local  association  to  the  National  Reserve 
Association  shall  not  at  any  time  exceed  the  aggregate  capital  and 
surplus  of  the  banks  forming  the  guaranteeing  association. 

Sec.  21.  Any  local  association  may  by  a  vote  of  three-fourths  of 
its  members  and  with  the  approval  of  the  National  Reserve  Associa- 
tion, assume  and  exercise  such  of  the  powers  and  functions  of  a  clear- 
ing house  as  are  not  inconsistent  with  the  purposes  of  this  act.  The 
National  Reserve  Association  may  require  any  local  association  to 
I>erform  such  services  in  facilitating  the  domestic  exchanges  of  the 
National  Reserve  Association  as  the  public  interests  may  require. 

Sec.  22.  All  of  the  privileges  and  advantages  of  the  National  Re- 
serve Association  shall  be  equitably  extended  to  every  bank  of  any  of 
the  classes  herein  defined  which  shall  subscribe  to  its  proportion  of 
the  capital  stock  of  the  National  Reserve  Association  and  shall  other- 
wise conform  to  the  requirements  of  this  act:  Provided,  That  the  Na- 
tional Reserve  Association  may  suspend  a  bank  from  the  privileges  of 
membership  for  refusal  to  comply  with  such  requirements  or  for  a 
failure  for  thirty  days  to  maintain  its  reserves,  or  to  make  the  reports 
required  by  this  act,  or  for  misrepresentation  in  any  report  or  exam- 
ination as  to  its  condition  or  as  to  the  character  or  extent  of  its  assets 
or  liabilities. 

Sec.  23.  The  National  Reserve  Association  shall  be  the  principal 
fiscal  agent  of  the  Upited  States.  The  Government  of  the  United 
States  shall  upon  the  organization  of  the  National  Reserve  Associa- 
tion deposit  its  general  funds  with  said  association  and  its  branches, 
and  thereafter  all  receipts  of  the  Government,  exclusive  of  trust  funds, 
shall  be  deposited  with  said  Association  and  its  branches,  and  all  dis- 
bursements by  the  Government  shall  be  made  through  said  associa- 
tion and  its  branches. 

Sec.  24.  The  Government  of  the  United  States  and  banks  own- 
ing stock  in  the  National  Reserve  Association  shall  be  the  only  deposi- 
tors in  said  association.  All  domestic  transactions  of  the  National 
Reserve  Association  shall  be  confined  to  the  Government  and  the 
subscribing  banks,  with  the  exception  of  the  purchase  or  sale  of  Gov- 
ernment or  State  securities  or  securities  of  foreign  governments  or  of 
gold  coin  or  bullion. 

Sec.  25.  The  National  Reserve  Association  shall  pay  no  interest 
on  deposits. 

Sec.  26.    The  National  Reserve  Association  may  through  a  branch 


338  APPENDIX  II 

rediscount  for  and  with  the  indorsement  of  any  bank  having  a  deposit 
with  it,  notes  and  bills  of  exchange  arising  out  of  commercial  transac- 
tions; that  is,  notes  and  bills  of  exchange  issued  or  drawn  for  agricul- 
tural, industrial,  or  commercial  purposes,  and  not  including  notes  or 
bills  issued  or  drawn  for  the  purpose  of  carrying  stocks,  bonds,  or  other 
investment  securities. 

Such  notes  and  bills  must  have  a  maturity  of  not  more  than  twenty- 
eight  daj's,  and  must  have  been  made  at  least  thirty  days  prior  to 
the  date  of  rediscount.  The  amount  so  rediscounted  shall  at  no  time 
exceed  the  capital  of  the  bank  for  which  the  rediscounts  are  made. 
The  aggregate  of  such  notes  and  bills  bearing  the  signature  or  indorse- 
ment of  any  one  person,  company,  firm,  or  corporation,  rediscounted 
for  any  one  bank,  shall  at  no  time  exceed  ten  per  centum  of  the  un- 
impaired capital  and  surplus  of  said  bank. 

Sec.  27.  The  National  Reserve  Association  may  through  a  branch 
also  rediscount,  for  and  with  the  indorsement  of  any  bank  having  a 
deposit  with  it,  notes  and  bills  of  exchange  arising  out  of  commercial 
transactions  as  hereinbefore  defined,  having  more  than  twenty-eight 
days,  but  not  exceeding  four  months,  to  run,  but  in  such  cases  the 
paper  must  be  guaranteed  by  the  local  association  of  which  the  bank 
asking  for  the  rediscount  is  a  member. 

Sec.  28.  Whenever,  in  the  opinion  of  the  governor  of  the  National 
Reserve  Association,  the  public  interests  so  require,  such  opinion  to 
be  concurred  in  by  the  executive  committee  of  the  National  Reserve 
Association  and  to  have  the  definite  approval  of  the  Secretary  of  the 
Treasury,  the  National  Reserve  Association  may  through  a  branch 
discount  the  direct  obligation  of  a  depositing  bank,  indorsed  by  its 
local  association,  provided  that  the  indorsement  of  the  local  associa- 
tion shall  be  fully  secured  by  the  pledge  and  deposit  with  it  of  satis- 
factory securities,  which  shall  be  held  by  the  local  association  for  ac- 
count of  the  National  Reserve  Association;  but  in  no  such  case  shall 
the  amount  loaned  by  the  National  Reserve  Association  exceed  three- 
fourths  of  the  actual  value  of  the  securities  so  pledged. 

Sec.  29.  The  power  of  rediscount  and  discount  granted  to  the 
National  Reserve  Association  by  sections  twenty-six,  twentj'-seven, 
and  twenty-eight  of  this  act  shall  in  each  case  be  exercised  through 
the  branch  in  the  district  in  which  the  bank  making  the  application 
is  located. 

Sec.  30.  The  National  Reserve  Association  shall  have  authority 
to  fix  its  rates  of  discount  from  time  to  time,  which  when  so  fixed 
shall  be  published,  and  shall  be  uniform  throughout  the  United  States. 

Sec.  31.  National  banks  are  hereby  authorized  to  accept  drafts 
or  bills  of  exchange  drawn  upon  them,  having  not  more  than  four 
months  to  run,  properly  secured,  and  arising  out  of  commercial  trans- 


APPENDIX  II  339 

actions  as  hereinbefore  defined.  The  amount  of  such  acceptances 
outstanding  shall  not  exceed  one-half  the  capital  and  surplus  of  the 
accepting  bank,  and  shall  be  subject  to  the  restrictions  of  section  fifty- 
two  hundred  of  the  Revised  Statutes. 

Sec.  32.  The  National  Reserve  Association  may,  whenever  its 
own  condition  and  the  general  financial  conditions  warrant  such  in- 
vestment, purchase  from  a  subscribing  bank  acceptances  of  banks  or 
acceptors  of  unquestioned  financial  responsibility  arising  out  of  com- 
mercial transactions  as  hereinbefore  defined.  Such  acceptances  must 
have  not  exceeding  ninety  days  to  run,  and  must  be  of  a  character 
generally  known  in  the  market  as  prime  bills.  Such  acceptances  shall 
bear  the  indorsement  of  the  subscribing  bank  selling  the  same,  which 
indorsement  must  be  other  than  that  of  the  acceptor. 

Sec.  33.  The  National  Reserve  Association  may  invest  in  United 
States  bonds;  also  in  obligations,  having  not  more  than  one  year  to 
run,  of  the  United  States  or  its  dependencies,  or  of  any  State,  or  of 
foreign  goveirnments. 

Sec.  34.  The  National  Reserve  Association  shall  have  power,  both 
at  home  and  abroad,  to  deal  in  gold  coin  or  bullion,  to  make  loans 
thereon,  and  to  contract  for  loans  of  gold  coin  or  bullion,  giving  there- 
for, when  necessary,  acceptable  security,  including  the  hypothecation 
of  any  of  its  holdings  of  United  States  bonds. 

Sec.  35.  The  National  Reserve  Association  shall  have  power  to 
purchase  from  its  subscribing  banks  and  to  sell,  with  or  without  its 
indorsement,  checks  or  bills  of  exchange,  arising  out  of  commercial 
transactions  as  hereinbefore  defined,  payable  in  such  foreign  coun- 
tries as  the  board  of  directors  of  the  National  Reserve  Association 
may  determine.  These  bills  of  exchange  must  have  not  exceeding 
ninety  days  to  run,  and  must  bear  the  signatures  of  two  or  more  re- 
sponsible parties,  of  which  the  last  one  shall  be  that  of  a  subscribing 
bank. 

Sec.  36.  The  National  Reserve  Association  shall  have  power  to 
open  and  maintain  banking  accounts  in  foreign  countries  and  to  estab- 
lish agencies  in  foreign  countries  for  the  purpose  of  purchasing,  selling, 
and  collecting  foreign  bills  of  exchange,  and  it  shall  have  authority  to 
buy  and  sell,  with  or  without  its  indorsement,  through  such  corre- 
spondents or  agencies,  checks  or  prime  foreign  bills  of  exchange  arising 
out  of  commercial  transactions,  which  have  not  exceeding  ninety 
days  to  run,  and  which  bear  the  signatures  of  two  or  more  responsible 
parties. 

Sec.  37.  It  shall  be  the  duty  of  the  National  Reserve  Association 
or  any  of  its  branches,  upon  request,  to  transfer  any  part  of  the  de- 
posit balance  of  any  bank  having  an  account  with  it  to  the  credit  of 
any  other  bank  having  an  account  with  the  National  Reserve  Asso- 


340  APPENDIX  H 

ciation.  If  a  deposit  balance  is  transferred  from  the  books  of  one 
branch  to  the  books  of  another  branch,  it  may  be  done,  under  regula- 
tions to  be  prescribed  by  the  National  Reserve  Association,  by  mail, 
telegraph,  or  otherwise,  at  rates  to  be  fixed  at  the  time  by  the  man- 
ager of  the  branch  at  which  the  transaction  originates. 

Sec.  38.  The  National  Reserve  Association  may  purchase,  ac- 
quire, hold,  and  convey  real  estate  for  the  following  purposes  and  for 
no  other: 

First.  Such  as  shall  be  necessary  for  the  immediate  accommoda- 
tion in  the  transaction  of  the  business  either  of  the  head  office  or  of 
the  branches. 

Second.  Such  as  shall  be  mortgaged  to  it  in  good  faith  by  way  of 
security  for  debts  previously  contracted. 

Third.  Such  as  shall  be  conveyed  to  it  in  satisfaction  of  debts 
previously  contracted  in  the  course  of  its  dealings. 

Fourth,  Such  as  it  shall  purchase  at  sales  under  judgments,  de- 
crees, or  mortgages  held  by  said  association,  or  shall  purchase  to  secure 
debts  due  to  it. 

But  the  National  Reserve  Association  shall  not  hold  the  possession 
of  any  real  estate  under  mortgage  or  the  title  and  possession  of  any 
real  estate  purchased  to  secure  any  debts  due  to  it  for  a  longer  period 
than  five  years. 

Sec.  39.  All  subscribing  banks  must  conform  to  the  following  re- 
quirements as  to  reserves  to  be  held  against  deposits  of  various  classes, 
but  the  deposit  balance  of  any  subscribing  bank  in  the  National  Re- 
serve Association  and  any  notes  of  the  National  Reserve  Association 
which  it  holds  may  be  counted  as  the  whole  or  any  part  of  its  required 
reserve: 

First.  On  demand  deposits:  National  banks  in  different  localities 
shall  maintain  the  same  percentages  of  reserve  against  demand  de- 
posits as  is  now  required  by  law,  and  the  same  percentages  of  reserve 
against  demand  deposits  shall  be  required  of  all  other  subscribing 
banks  in  the  same  localities. 

Second.  On  time  deposits:  All  time  deposits  and  moneys  held  in 
trust  payable  or  maturing  within  thirty  days  shall  be  subject  to  the 
same  reserve  requirements  as  demand  deposits  in  the  same  locality. 
All  time  deposits  and  moneys  held  in  trust  payable  or  maturing  more 
than  thirty  days  from  date  shall  be  subject  to  the  same  reserve  require- 
ments as  demand  deposits  for  the  thirty  days  preceding  their  maturity, 
but  no  reserves  shall  be  required  therefor  except  for  this  period.  Such 
time  deposits  and  moneys  held  in  trust,  payable  only  at  a  stated  time 
not  less  than  thirty  days  from  date  of  deposit,  must  be  represented  by 
certificates  or  instruments  in  writing  and  must  not  be  allowed  to  be 
withdrawn  before  the  time  specified  without  thirty  days'  notice. 


APPENDIX  II  341 

Sec.  40.  National  banks  may  loan  not  more  than  thirty  per  cen- 
tum of  their  time  deposits,  as  herein  defined,  upon  improved  and  un- 
encumbered real  estate,  such  loans  not  to  exceed  fifty  per  centum  of 
the  actual  value  of  the  property,  which  property  shall  be  situated  in 
the  vicinity  or  in  the  territory  directly  tributary  to  the  bank:  Pro- 
vided.  That  this  privilege  shall  not  be  extended  to  banks  acting  as  re- 
serve agents  for  banks  or  trust  companies. 

Sec.  41.  All  demand  liabilities,  including  deposits  and  circulating 
notes,  of  the  National  Reserve  Association  shall  be  covered  to  the 
extent  of  fifty  per  centum  by  a  reserve  of  gold  (including  foreign  gold 
coin  and  gold  bullion)  or  other  money  of  the  United  States  which  the 
national  banks  are  now  authorized  to  hold  as  a  part  of  their  legal  re- 
serve: Provided,  That  whenever  and  so  long  as  such  reserve  shall  fall 
and  remain  below  fifty  per  centum  the  National  Reserve  Association 
shall  pay  a  special  tax  upon  the  deficiency  of  reserve  at  a  rate  increas- 
ing in  proportion  to  such  deficiency  as  follows :  For  each  two  and  one- 
half  per  centum  or  fraction  thereof  that  the  reserve  falls  below  fifty 
per  centum  a  tax  shall  be  levied  at  the  rate  of  one  and  one-half  per 
centum  per  annum :  Provided  further.  That  no  additional  circulating 
notes  shall  be  issued  whenever  and  so  long  as  the  amount  of  such  re- 
serve falls  below  thirty-three  and  one-third  per  centum  of  its  out- 
standing notes. 

Sec.  42.  In  computing  the  demand  liabilities  of  the  National  Re- 
serve Association  a  sum  equal  to  one-half  of  the  amount  of  the  United 
States  bonds  held  by  the  association  which  have  been  purchased  from 
national  banks,  and  which  had  previously  been  deposited  by  such 
banks  to  secure  their  circulating  notes,  shall  be  deducted  from  the 
amount  of  such  liabilities. 

Sec.  43,  The  National  Reserve  Association  shall  make  a  report, 
showing  the  principal  items  of  its  balance  sheet,  to  the  Comptroller 
of  the  Currency  onqe  a  week.  These  reports  shall  be  made  public. 
In  addition,  full  reports  shall  be  made  to  the  Comptroller  of  the  Cur- 
rency by  said  association  coincident  with  the  five  reports  called  for 
each  year  from  the  national  banks. 

Sec.  44.  All  subscribing  banks  shall,  under  regulations  to  be  pre- 
scribed by  the  National  Reserve  Association  make  a  report  monthly, 
or  oftener  if  required,  to  said  association  showing  the  principal  items 
of  their  balance  sheets. 

Sec.  45.  All  reports  of  national-bank  examiners  m  regard  to  the 
condition  of  banks  shall  hereafter  be  made  in  duplicate,  and  one  copy 
shall  be  filed  with  the  National  Reserve  Association  for  the  confiden- 
tial use  of  its  executive  officers  and  branch  managers. 

Sec.  46.  The  National  Reserve  Association  may  accept  copies  of 
the  reports  of  the  national-bank  examiners  for  subscribing  national 


342  APPENDIX  II 

banks  and  also  copies  of  the  reports  of  State-bank  examiners  for  sub- 
scribing State  banks  and  trust  companies,  in  States  where  the  furnish- 
ing of  such  information  is  not  contrary  to  law:  Provided,  however. 
That  the  standard  of  such  examinations,  both  National  and  State, 
meets  the  requirements  prescribed  by  the  National  Reserve  Associa- 
tion. The  National  Reserve  Association  shall  have  the  right  at  any 
time  to  examine  or  cause  to  be  examined  by  its  own  representatives 
any  subscribing  bank.  The  National  Reserve  Association  may  make 
such  payments  to  national  and  State  examiners  for  such  services  re- 
quired of  them  as  the  directors  may  consider  just  and  equitable. 

Sec.  47.  All  provisions  of  law  requiring  national  banks  to  hold 
or  to  transfer  and  deliver  to  the  Treasurer  of  the  United  States  bonds 
of  the  United  States  other  than  those  required  to  secure  outstanding 
circulating  notes  and  Government  deposits  are  hereby  repealed. 

Sec.  48.  There  shall  be  no  further  issue  of  circulating  notes  by 
any  national  bank  beyond  the  amount  now  outstanding.  National 
banks  may  maintain  their  present  note  issue,  but  whenever  a  bank 
retires  the  whole  or  any  part  of  its  existing  issue  its  right  to  reissue 
the  notes  so  retired  shall  thereupon  cease. 

Sec.  49.  The  National  Reserve  Association  shall,  for  a  period  of 
one  year  from  the  date  of  its  organization,  ofiFer  to  purchase  at  a  price 
not  less  than  par  and  accrued  interest  the  two  per  centum  bonds  held 
by  subscribing  national  banks  and  deposited  to  secure  their  circulat- 
ing notes.  The  National  Reserve  Association  shall  take  over  the 
bonds  so  purchased  and  assume  responsibility  for  the  redemption  upon 
presentation  of  outstanding  notes  secured  thereby.  The  National 
Reserve  Association  shall  issue,  on  the  terms  herein  provided,  its  own 
notes  as  the  outstanding  notes  secured  by  such  bonds  so  held  shall  be 
presented  for  redemption  and  may  issue  further  notes  from  time  to 
time  to  meet  business  requirements,  it  being  the  policy  of  the  United 
States  to  retire  as  rapidly  as  possible,  consistent  with  the  public  in- 
terests, bond-secured  circulation  and  to  substitute  therefor  notes  of 
the  National  Reserve  Association  of  a  character  and  secured  and  re- 
deemed in  the  manner  provided  for  in  this  act. 

Sec.  50.  All  note  issues  of  the  National  Reserve  Association  shall 
at  all  times  be  covered  by  legal  reserves  to  the  extent  required  by 
section  forty-one  of  this  act  and  by  notes  or  biUs  of  exchange  arising 
out  of  commercial  transactions  as  hereinbefore  defined  or  obligations 
of  the  United  States. 

Sec.  51.  Any  notes  of  the  National  Reserve  Association  in  cir- 
culation at  any  time  in  excess  of  nine  hundred  million  dollars  which 
are  not  covered  by  an  equal  amount  of  lawful  money,  gold  bullion,  or 
foreign  gold  coin  held  by  said  association,  shall  pay  a  special  tax  at 
the  rate  of  one  and  one-half  per  centum  per  annum,  and  any  notes 


APPENDIX  II  343 

in  excess  of  one  billion  two  hundred  million  dollars  not  so  covered  shall 
pay  a  special  tax  at  the  rate  of  five  per  centum  per  annum:  Provided, 
That  in  computing  said  amounts  of  nine  hundred  million  dollars  and 
one  billion  two  hundred  million  dollars  the  aggregate  amount  of  any 
national-bank  notes  then  outstanding  shall  be  included. 

Sec.  52.  The  circulatiag  notes  of  the  National  Reserve  Associa- 
tion shall  constitute  a  first  lien  upon  all  its  assets  and  shall  be  re- 
deemable in  lawful  money  on  presentation  at  the  head  office  of  said 
association  or  any  of  its  branches.  It  shall  be  the  duty  of  the  National 
Reserve  Association  to  maintain  at  all  times  a  parity  of  value  of  its 
circulating  notes  with  the  standard  established  by  the  first  section  of 
the  act  of  March  fourteenth,  nineteen  hundred,  entitled  "An  act  to 
define  and  fix  the  standard  of  value,  to  maintain  the  parity  of  all 
forms  of  money  issued  or  coined  by  the  United  States,  to  refund  the 
public  debt,  and  for  other  purposes." 

Sec.  53.  The  circulating  notes  of  the  National  Reserve  Associa- 
tion shall  be  received  at  par  in  payment  of  all  taxes,  excises,  and 
other  dues  to  the  United  States,  and  for  all  salaries  and  other  debts 
and  demands  owing  by  the  United  States  to  individuals,  firms,  cor- 
porations, or  associations,  except  obligations  of  the  Government 
which  are  by  their  terms  specifically  payable  in  gold,  and  for  all  debts 
due  from  or  by  one  bank  or  trust  company  to  another,  and  for  all 
obligations  due  to  any  bank  or  trust  company. 

Sec.  54.  The  National  Reserve  Association  and  its  branches  shall 
at  once,  upon  application  and  without  charge  for  transportation,  for- 
ward its  circulating  notes  to  any  depositing  bank  against  its  credit 
balance. 

Sec.  55.  Upon  application  of  the  National  Reserve  Association 
the  Secretary  of  the  Treasury  shall  exchange  the  two  per  centum  bonds 
of  the  United  States  bearing  the  circulation  privilege  purchased  from 
subscribing  banks  for  three  per  centum  bonds  of  the  United  States 
without  the  circulation  privilege,  payable  after  fifty  years  from  the 
date  of  issue.  The  National  Reserve  Association  shall  hold  the  three 
per  centum  bonds  so  issued  during  the  period  of  its  corporate  exist- 
ence: Provided,  That  after  five  years  from  the  date  of  its  organization 
the  Secretary  of  the  Treasury  may  at  his  option  permit  the  National 
Reserve  Association  to  sell  not  more  than  fifty  million  dollars  of  such 
bonds  annually:  And  provided  further.  That  the  United  States  reserves 
the  right  at  any  time  to  pay  any  of  such  bonds  before  maturity,  or  to 
purchase  any  of  them  at  par  for  the  trustees  of  the  postal  savings,  or 
otherwise. 

Sec.  5Q.  The  National  Reserve  Association  shall  pay  to  the  Gov- 
ernment a  special  franchise  tax  of  one  and  one-half  per  centum  annually 
during  the  period  of  its  charter  upon  an  amount  equal  to  the  par 


344  APPENDIX  II 

value  of  such  United  States  bonds  transferred  to  it  by  the  subscribing 
banks. 

Sec.  57.  That  banking  corporations  for  carrying  on  the  business 
of  banking  in  foreign  countries  and  in  aid  of  the  commerce  of  the 
United  States  with  foreign  countries  and  to  act  when  required  as 
fiscal  agents  of  the  United  States  in  such  countries  may  be  formed  by 
any  number  of  persons,  not  less  in  any  case  than  five,  who  shall  enter 
into  articles  of  association  which  shall  specify  in  general  terms  the 
object  for  which  tlie  banking  corporation  is  formed  and  may  contain 
any  other  provisions  not  inconsistent  with  the  provisions  of  this  sec- 
tion which  the  banking  corporation  may  see  fit  to  adopt  for  the  regu- 
lation and  conduct  of  its  business  and  affairs,  which  said  regulations 
shall  be  signed,  in  duplicate,  by  the  persons  uniting  to  form  the  bank- 
ing corporation  and  one  copy  thereof  shall  be  forwarded  to  the  Comp- 
troller of  the  Currency  and  the  other  to  the  Secretary  of  State,  to  be 
filed  and  preserved  in  their  offices. 

That  the  persons  uniting  to  form  such  banking  corporation  shall 
under  their  hands  make  an  organization  certificate  which  shall  specify, 
first,  the  name  assumed  by  such  banking  corporation,  which  name 
shall  be  subject  to  approval  by  the  comptroller;  second,  the  foreign 
country  or  countries  or  the  dependencies  or  colonies  of  foreign  coun- 
tries or  the  dependencies  of  the  United  States  where  its  banking  opera- 
tions are  to  be  carried  on;  third,  the  place  in  the  United  States  where 
its  home  office  shall  be  located;  fourth,  the  amount  of  its  capital  stock 
and  the  number  of  shares  into  which  the  same  shall  be  divided;  fifth, 
the  names  and  places  of  residence  of  the  shareholders  and  the  number 
of  shares  held  by  each  of  them;  and,  sLxth,  a  declaration  that  said 
certificate  is  made  to  enable  such  persons  to  avail  themselves  of  the 
advantages  of  this  section. 

That  no  banking  corporation  shall  be  organized  under  the  pro- 
visions of  this  section  with  a  less  capital  than  two  million  dollars, 
which  shall  be  fully  paid  in  before  the  banking  corporation  shall  be 
authorized  to  commence  business,  and  the  fact  of  said  payment  shall 
be  certified  by  the  Comptroller  of  the  Currency  and  a  copy  of  his  cer- 
tificate to  this  effect  shall  be  filed  with  the  Secretary  of  State:  Provided, 
That  the  capital  stock  of  any  such  bank  may  be  increased  at  any 
time  by  a  vote  of  two-thirds  of  its  shareholders  with  the  approval  of 
the  Comptroller  of  the  Currency  and  that  the  capital  stock  of  any 
such  bank  which  exceeds  two  million  dollars  may  be  reduced  at  any 
time  to  the  sum  of  two  million  dollars  by  the  vote  of  shareholders 
owning  two-thirds  of  the  capital. 

That  every  bankmg  corporation  formed  pursuant  to  the  provisions 
of  this  section  shall  for  a  period  of  twenty  j'cars  from  the  date  of  the 
execution  of  its  organization  certificate  be  a  body  corporate,  but  shall 


APPENDIX  II  345 

not  be  authorized  to  receive  deposits  in  the  United  States  nor  transact 
any  domestic  business  not  necessarily  related  to  the  business  being 
done  in  foreign  countries  or  in  the  dependencies  of  the  United  States. 
Such  banking  corporations  shall  have  authority  to  make  acceptances, 
buy  and  sell  bills  of  exchange,  or  other  commercial  paper  relating  to 
foreign  business,  and  to  purchase  and  sell  securities,  including  securi- 
ties of  the  United  States  or  of  any  State  in  the  Union.  Each  banking 
corporation  organized  under  the  provisions  of  this  section  shall  have 
power  to  establish  and  maintain  for  the  transaction  of  its  business  a 
branch  or  branches  in  foreign  countries,  their  dependencies,  or  the  de- 
pendencies of  the  United  States  at  such  places  and  under  such  regula- 
tions as  its  board  of  directors  may  deem  expedient. 

A  majority  of  the  shares  of  the  capital  stock  of  such  banking  cor- 
poration shall  be  held  and  owned  by  citizens  of  the  United  States  or 
corporations  chartered  under  the  laws  of  the  United  States  or  of  any 
State  of  the  Union,  and  a  majority  of  the  members  of  the  board  of 
directors  of  such  banking  corporations  shall  be  citizens  of  the  United 
States.  Each  director  shall  own  in  his  own  right  at  least  one  himdred 
shares  of  the  capital  stock  of  the  banking  corporation  of  which  he  is 
a  director. 

Whenever  the  Comptroller  shall  become  satisfied  of  the  insolvency 
of  any  such  banking  corporation  he  may  appoint  a  receiver  who  shall 
proceed  to  close  up  such  corporation  in  the  same  manner  in  which  he 
would  close  a  national  bank,  the  disposition  of  the  assets  of  the  branches 
to  be  subject  to  any  special  provisions  of  the  laws  of  the  country  un- 
der whose  jurisdiction  such  assets  are  located. 

The  annual  meeting  of  every  such  banking  corporation  shall  be 
held  at  its  home  oflSce  in  the  United  States,  and  every  such  banking 
corporation  shall  keep  at  its  home  office  books  containing  the  names 
of  all  stockholders  of  such  banking  corporation  and  members  of  its 
board  of  directors,  together  with  copies  of  the  reports  furnished  by  it 
to  the  Comptroller  of  the  Currency  exhibiting  in  detail  and  imder 
appropriate  heads  the  resources  and  liabilities  of  the  banking  corpora- 
tion. Every  such  banking  corporation  shall  make  reports  to  the 
Comptroller  of  the  Currency  at  such  times  as  he  may  require,  and 
shall  be  subject  to  examinations  when  deemed  necessary  by  the  Comp- 
troller of  the  Currency  through  examiners  appointed  by  him;  the 
compensation  of  such  examiners  to  be  fixed  by  the  Comptroller  of  the 
Currency. 

Any  such  banking  corporation  may  go  into  liquidation  and  be 
closed  by  the  vote  of  its  shareholders  owning  two-thirds  of  its  stock. 

Any  bank  doing  business  in  the  United  States  and  being  the  owner 
of  stock  in  the  National  Reserve  Association  may  subscribe  to  the 
stock  of  any  banking  corporation  organized  under  the  provisions  of 


346  APPENDIX  II 

this  section,  but  the  aggregate  of  such  stock  held  by  any  one  bank 
shall  not  exceed  ten  per  centum  of  the  capital  stock  of  the  subscribing 
bank. 

Sec.  58.  Congress  reserves  the  right  to  alter  or  amend  the  pro- 
visions of  this  act  to  take  effect  at  the  end  of  any  decennial  period 
from  and  after  the  organization  of  the  National  Reserve  Association. 

Sec.  59.  All  acts  or  parts  of  acts  inconsistent  with  the  provisions 
of  this  act  are  hereby  repealed. 


INDEX 


Acceptances,  272-274,  219,  281-283; 
trade.  282. 

Act.  of  1870.  Refunding.  4.  5;  of  1875. 
Redemption.  5,  51;  of  1878,  6.  51; 
of  1882,  24;  of  1890,  9,  n.  1,  11-13, 
17,  51, 149;  of  1893,  9.  n.  1;  of  1898. 
Spanish  War  Loan,  5,  13;  of  1907, 
24,  41,  n.;    of  September  7,  1916, 

287,  292,  296;   June  21,  1917,  287, 

288,  292,  304,  309;  of  September  26, 

1918,  289,  290;    of  December  24, 

1919,  Edge.  296. 

Aldrich,  Senator,  54,  55,  57,  68,  69, 
125,  145,  147,  152.  See  Nat.  Mon. 
Com. 

Aldrich-Vreeland  Act,  50-80,  127, 
143,  192,  301;  currency  associa- 
tions of,  60,  64-66,  125,  143. 

American  Bankers'  Association,  bill 
of,  37,  39,  45-47.  50,  160.  220.  246. 
293.  n.  1. 

Baltimore  Plan,  27-30,  32,  36. 

Bank  of  England,  128-129;  in  time 
of  panic,  43,  44,  n.,  135,  140,  141; 
act  of  1844,  257,  315;  agent  of  Re- 
serve Bank.  297;  fiscal  agent,  298; 
gold  behind  notes  of,  305. 

Bank  of  France,  128-129,  136-137. 
189,  236;  agent  of  Reserve  Bank, 
297. 

Bankers*  bills,  175. 

Banking,  evolution  of,  1,  19,  20,  38, 
50,  81;  prejudice  against,  33;  func- 
tions of,  confused,  157-159. 

Bank-notes,  supposed  pivotal,  20; 
seasonal  demand  for,  25;  issue  of, 
when  needed,  39,  47;  bond-seciu-ed, 
inelastic,  23,  63,  166;  no  remedy 
for  panic,  41-43,  47,  127-131,  143; 


secured  by  commercial  paper,  65- 
80;  elasticity  of,  126;  marginal 
elasticity  of,  138-140;  functions  of, 
243-244;   leaning  to,  in  war,  297. 

Banks,  profits  of,  22,  32-33;  services 
rendered  by,  108. 

Bonds,  of  United  States,  in  1900,  5,  6; 
how  payable,  4,  7;  extended  2s,  17; 
for  securing  notes,  17,  65;  prices  of, 
21;  security  for  public  deposits,  41; 
scarce,  64;  Panama,  53;  railway, 
69,  70. 

Bryan,  W.  J.,  52,  102,  115,  119,  146, 
149,  150. 

Burton,  T.  E.,  59. 

Canadian  banking,  25,  177. 

Carlisle,  Secretary,  29.  34. 

Clearing-house,  certificates  of,  38,  40, 
53,  74,  79,  127,  134,  139,  283,  301. 

Clearings,  212-215,  268-271,  291-293. 

Cleveland,  President,  51,  149. 

Commercial  paper,  66-79,  262-263. 

Cortelyou,  Secretary,  65. 

Credit,  elasticity  of,  19,  26,  143,  161- 
162,  165;  centralization  and  con- 
trol of.  163,  165;  in  Federal  Reserve 
Act,  257-264,  308-311. 

Crisis,  in,  need  is  lending  power,  44; 
proposed  remedy  for,  31-32,  39,  41, 
47-48,  92;  to  prevent,  137-142; 
cause  of,  34,  95;  of  1893,  1,  19,  40; 
of  1907,  38^9,  52,  63-64,  74,  81- 
83,  95;  of  1907,  led  to  monetary 
reform,  124;  need  of  bank-notes 
in,  1907,  127;  three  important  hap- 
penings in,  1907,  131-134. 

Currency,  system  of  U.  S.,  defects  of, 
161-163,  216;  reform,  summary  in 
1912,  161. 


347 


348 


INDEX 


Democratic  party,  policy  of,  51,  54, 
146,  148,  149.  150,  £18,  n. 

Deposit-currency,  20,  26,  31,  38-39, 
46,  86. 

Dunbar,  C.  F..  245,  n. 

Edge  Act,  December  24,  1919,  296. 

Elasticity,  meaning  of,  19;  over- 
emphasized, 26;  of  national  bank- 
notes, 20-27;  of  Canadian  and 
Scotch  bank-notes,  25;  of  credit, 
26,  27;  in  both  demand-liabilities, 
32;  lacking  in  1907,  127;  of  note- 
issues  not  a  remedy  for  panics,  31- 
32,  43,  47-48,  127-131;  marginal, 
40,  138;  in  proposed  bill,  187;  of 
Federal  Reserve  notes.  239,  260. 

Federal  Land  Bank,  285. 

Federal  Reserve  Act.  20,  22,  27;  early 
suggestion  of,  140-142;  political 
history  of,  143-159;  preliminary 
draft  of,  150-151;  origin  of,  151- 
153,  100-215;  memorandum  on 
political  situation,  153-154;  how 
related  to  clearing-houses,  164-165; 
organization  and  control.  217-229. 
278;  powers  of  board.  221;  ques- 
tion of  central  bank.  227.  236; 
powers  of  Reserve  Banks,  230; 
agents  in  placing  loans,  298;  elec- 
tion of  directors,  232;  dislike  of 
rediscounling.  234;  open-market 
dealings.  285.  283;  confirmed  gold 
standard.  3,  237-238;  Federal  Re- 
serve notes,  238-245,  301-307; 
Federal  Reserve  Bank  notes,  302; 
expansion  under.  243-245.  264-2G8. 
299-304,  307,  308-317;  disposal  of 
bonds  to  secure  notes,  245-249;  re- 
serves, 249-256,  265,  285,  288,  295, 
305;  reserve  for  both  notes  and 
deposits,  16,  106,  1S5,  189,  256,  288, 
305,  316;  elasticity  of  credit,  257- 
264;  clearings,  268-271,  291-294 
discount  market.  272-274.  283 
foreign  banking  facilities.  274,  296 
independent  treasury.  275,  298,  301 
inducements  to  State  bonks,  276, 


286,  287.  288-290;  in  pank:  of  1914, 
278;  kinds  of  paper  rediscounted, 
279;  rates  of  discounts,  284;  prefer- 
ential on  war  paper,  284-285,  300, 
309,  313;  meaning  of  par  list,  293; 
gold  settlement  fund,  293-294; 
transfers,  293;  convertibilitj'  into 
gold.  295.  304.  314;  effect  of  war, 
297-301;  government  deposits, 
298. 

Finance  bills,  74,  175. 

Fowler  Bill,  39,  45,  47,  50.  57-59,  61, 
83. 

Free-Banking  Act,  1838.  189. 

Glass,  Carter,  147,  149,  151,  153,  160. 
218,  245. 

Gold,  production  of,  1850-1893,  30; 
not  scarce,  42;  basb,  294-296;  in 
foreign  agencies,  297.  See  Standard. 

Gregory,  Attorney-General,  292,  n.  2. 

Guaranty  of  deposits,  piuT>ose  of,  82- 
83;  origin  of.  82.  90;  forbidden  to 
national  banks.  85,  120;  different 
positions  of  noteholder  and  deposi- 
tor. 85-86;  depositor,  a  voluntary 
creditor,  87-88;  plan  socialistic,  89- 
91;  safety  of  deposits  depends  on 
assets,  92,  94,  109;  no  remedy  for 
panics.  92-96;  justice  of.  88.  108- 
110,  115;  not  for  savings-banks,  84; 
immtxliate  renlemption  impossible, 
83,  105.  112;  and  note-issues.  97- 
100.  122;  results  in  bad  banking, 
100-103.  116-118;  viewed  as  tc<h- 
nical  insurance.  104;  and  Safety 
Fund  Act.  105;  now  exists.  Ill; 
no  absolute  security.  113;  in  Okla- 
homa. 112,  118;  as  affecting  SUte 
banks,  120-121;  and  postal  sav- 
ings. 121. 

Independent  subtreasurj-,  208-209; 
in  Reserve  Act,  275,  298;  not  abol- 
ished. 301. 

Inspections.  103. 

Investment  securities  as  assets,  158. 

Issue  and  redemption  in  Treasury 
separated,  15-16. 


INDEX 


349 


La  Follette,  Senator.  56. 

Legal  tender,  and  standard,  6,  7;    of 

silver  dollars,  8. 
Lending  power,  44,  124-142,  202. 

MacVeagh,  Secretary  F.,  66,  n.,  125, 

143. 
McAdoo,  Secretarj-,  247,  n.,  248. 
Monetary   and   fiscal    functions,    15; 

confused  by  Federal  Reserve  Act, 

16;   should  be  separated,  138. 
Monetary  Commission,  Indianapolis, 

36-37,  50,  57,  160. 
Monetary    legislation,    methods    of, 

155-157. 
Money,  function  of,  33-34;    scarcity 

of,  42;   errors  about,  33-36. 

National  bank  notes,  why  inelastic, 
20-26,  38;  redemption  of,  24;  de- 
pendent on  profit  to  bank,  21 ;  lim- 
ited by  supply  of  bonds,  23;  con- 
traction of,  delayed,  24;  relation 
to  silver  currency,  48;  to  be  re- 
placed by  lleserve  notes,  238,  241- 
243.  302. 

National  Citizens*  League.  148,  n. 

National  Monetary  Commission.  61, 

124,   134.  137,   144,  162,  228.  249. 

It  272;    origin   of  plan  of,   145;    fell 

•        dead,     147;      relation    to    Federal 

Reserve  Act,  152. 

Note-brokers,  78,  263. 

Owen,  Senator,  246. 

Parity  between  gold  and  silver,  9-14. 
Pujo,  147. 

Redemption  Fund,  75. 
Republican  party,  policy  of,  61-52, 
146,  149. 


Reserves,  fixed.  35;  not  scarce.  42; 
means  to  increase,  44-45;  how  ob- 
tained. 45;  general  principles  of, 
201-204;  in  Federal  Reserve  Act, 
249-256.  305. 

Roosevelt.  President,  53. 

Scott.  W.  A..  253.  n. 

Shaw.  Secretary,  248,  n. 

Silver.  2,  3.  4.  5,  8;  parity  with  gold, 
8-14.  237;  rise  in  1919,  12  n..  48; 
private  contracts  payable  in,  8. 

Soetbeer.  A..  30. 

Sprague.  O.  M.  W.,  244,  n. 

Standard  question,  1;  meaning  of,  3; 
progress  from,  to  credit,  1,  19; 
Gold  Standard  Act.  1900,  2,  4.  5,  6, 
8,  14,  15,  19,  36,  48,  52;  established 
by  Federal  Reserve  Act,  3,  237-238. 

Tax  on  circulation,  17,  71-72,  75. 

Trade  paper,  76. 

Transfers.  293. 

Treasury    board.    165-172.    176-180; 

relations    to    district    associations, 

181-184. 
Treasury  notes,  in  proposed  bill,  184- 

198;  not  in  reserves.  203;   treasury 

notes  of  1890,  9,   11,   13,   14,   16; 

why  disappeared,  12-14. 

Untermyer,  S.,  147. 

U.  S.  Bank,  Second.  51. 

U.  S.  notes,  4,  10,  11,  14,  16.  20;  re- 
tirement of.  35-36;  inelastic,  38, 
237;  should  be  withdrawn,  35,  237. 

War   Finance   Corporation,    280,    n., 

300,  307,  n.  3. 
Willis.  H.  P.,  151. 
Wilson,  Woodrow,  146,  147,  148,  149, 

150,  153,  154,  219,  226,  290. 


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